Stoller 17 cookies with milken
It was 1986, and one of the most popular television shows was Dallas, about the oil tycoon J. R. Ewing and that most Texan of dreams, to get rich through scheming. At a Beverly Hills conference for Wall Street financiers, the actor Larry Hagman, who played J. R., riffed on a popular commercial for the American Express credit card, speaking instead of his “Drexel Express titanium card,” named after the most powerful investment bank of those days, Drexel Burnham Lambert. The card, he said, “has a ten-billion-dollar line of credit… don’t go hunting without it.” The men in the audience admired J. R.’s daring, wealth, scheming, and most of all, perhaps, his use of borrowed money to ruthlessly capture or crush rival corporations.
This was anything but Wright Patman’s Texas, which traced back to the late nineteenth century and the Farmers’ Alliance demands for low interest rates and fair markets. J. R.’s Texas culture was formed in the 1940s, with billionaire financiers in short sleeves play-acting cowboy on Wall Street, as captured in books with titles such as The Lusty Texans of Dallas, Houston: Land of the Big Rich, and The Super-Americans. By the 1980s, it was no longer just Texas oil fraud, but Texas land fraud and Texas savings and loan fraud that minted the new millionaires.
After the Iranian revolution in 1979, the skyrocketing of the prices of oil resulted in one of the largest transfers of wealth in history, from oil consumers in the West to oil producers. No one but Arabs, Venezuelans, and Texans seemed to be doing well. The stock market was catatonic, inflation and interest rates catastrophic. In such an environment, the Federal Reserve couldn’t even really print money without stoking more inflation. But the Texans and the Saudis could always pump more oil.
The new culture of greed in the oil patch reverberated across America, and around the world. The 1980 episode of Dallas “Who shot J. R.?” was the second-highest-rated prime time show in American history. The mother of the Queen of England begged Larry Hagman to tell her who did it. He refused. Hagman later claimed that the show, broadcast in communist Romania, helped bring down the country’s dictator by illustrating to the forlorn people the luxuries available in the West.
Hagman was a special guest at the 1986 party of the biggest names on Wall Street, nicknamed the “Predators’ Ball.” More formally, it was called the “Drexel High-Yield Bond Department Annual Conference,” high-yield debt being the preferred name for junk bonds. Dallas and J. R. were a perfect bridge between the oil-shock-driven 1970s and the “Greed is good” Wall Street–oriented decade of the 1980s.
The gathered wealth represented, according to one participant, three times the GNP of the U.S.2 So powerful was this combination of financial firepower and lax merger rules that the Predators’ Ball—held annually and increasing in prestige until the end of the decade—became a forum for thousands of the most important people in finance, as well as those trying to peek into this world of luxury. Attendees included oil magnate and corporate raider T. Boone Pickens, media barons Rupert Murdoch, Barry Diller, and Ted Turner, cell phone pioneer Craig McCaw, financial kingpin Ronald Perelman, revolutionary corporate raiders Carl Icahn and Henry Kravis, Las Vegas casino magnate Steve Wynn, and countless CEOs, celebrities, and politicians, as well as striking workers to picket them.3
By 1986, the conference had become an orgy of fame, money, sex, arbitrage, politics, and mergers. Frank Sinatra once made an appearance for a cool $150,000 fee. Diana Ross sang, changing outfits twice during her routine.4 Country music star Dolly Parton performed. A Madonna look-alike danced and lip-synced to her famous song “Material Girl,” changing the lyrics to “I’m a double-B girl living in a material world,” in a nod to both bra sizes and junk bond ratings.5
On the second night, the VIPs of the event, some hundred of the “real players”—people with large amounts of money, access to money, or deal lawyers—attended a private party and dinner. Arbitrageur Martin Weinstein made a wry comment, noting that a corporate raider named Irwin Jacobs “had been in deep conversation for hours with one of these women at the far end of the room.” Weinstein said, “Tell Irwin he doesn’t have to work so hard. She’s already paid for.”6
Such was life among financial raiders, schemers, looters, and fraudsters of the 1980s who were not content with yachts and private jets, but sought entire corporations to fit into burgeoning industrial empires. The investment bank Drexel Burnham Lambert was the center of the swirling greed, the industry leader and near monopolist of the corporate restructuring of the 1980s. And Drexel was run in all but name by the most influential banker on Wall Street since Andrew Mellon: Michael Milken. The J. R. Ewing sketch was Milken’s doing. It was symbolism, and potent, at that.
Milken represented the return of the final component of Mellonism, the unbridled power of the financier to shape the real economy to serve his own ends. Milken used the corporation and the bank as a means of moving investors’ capital—other people’s money—into his own pocket. Unlike Saul Steinberg in the 1960s, Milken was free from restrictions on financial capital, and free from antitrust rules or banking regulations. He could use borrowed money or trading instruments however he saw fit.
Milken got his start in 1969, entering a second-tier Wall Street firm as a trader in bonds of high-risk companies. Because the bonds Milken traded were risky, they paid a high interest rate. Often these were companies known as “fallen angels” that had been considered good credit risks, like Penn Central, but had defaulted. There was no public listing for these bonds, which Wall Street soon dubbed “junk bonds.” In the 1970s, most of the midlevel investment banks that raised money for these kinds of firms disappeared, leaving a funding gap for smaller and younger companies.7
Smaller and medium-sized companies presented a special challenge for financial markets. For one, they didn’t have enough of a reputation or track record that investors could rely on. These kinds of companies typically borrowed money via direct lending through banks. A banker could monitor a company directly, unlike atomized investors who held small bits of these corporations’ paper. But as banking declined in importance versus the increasingly unregulated financial system, so did the financing channels for newer and riskier ventures.
In another era, Milken would have become a modestly successful specialist in a backwater area of Wall Street, or perhaps a small-scale white-collar crook. But Milken would take advantage of, and pushed, the newly lax legal context for finance. There was another risk in lending to unknown, lesser known, or weaker companies without adequate supervision. This kind of lending could be easily corrupted. Two economists, George Akerlof and Paul Romer, observed the danger. As they put it in 1993, a “limited liability corporation could borrow money, pay it into the private account of the owners, and then default on its debt.”8 This danger was especially acute when the person in charge of lending the money was in on the scam. He or she could get money from investors, “lend” it to unknown companies, and then transfer the money to his or her own pocket by taking a cut. New Deal financial reforms were designed to block just such behavior, which had been done by the financiers of the 1920s.
Michael Milken became the architect of a complex and corrupt financial system based on engaging in this kind of looting. It started relatively small. He would entice investors into buying junk bonds of unknown companies that yielded high interest, and then take large fees from the deal flow. Milken had to ensure that these bonds paid out their interest, or at the very least, that investors who held these bonds could sell them in a market. Otherwise, investors would stop buying junk.
Milken somehow made this work by standing in between the junk bond buyer and the company issuing the debt. If you bought Drexel junk, Milken would always be willing to buy back your bonds, no matter how the underlying corporation that issued the bonds did. Somehow, even if the bond was outlandishly risky or close to worthless, Milken could always find a willing buyer, or take you out of it himself. Bond buying is a form of lending, and, normally, bond buyers care about whether the borrower will pay them back. But Milken stood in the middle between a lender and a borrower, and would ensure bond buyers were paid back regardless of how the borrower did. He could do this because he was stashing losses within captive pools of capital he controlled, like mutual funds, insurance companies, thrifts, and pension funds, aka other people’s money.9
But who were these buyers willing to buy worthless junk bonds? Milken realized he needed to find men who controlled pools of other people’s money and who were willing to hide losses for him. He found them among the dregs of Wall Street, the scam artists who lived in the gray areas of the financial world. These men wanted access to junk bond financing, so they had an incentive to help Milken create what looked like a vibrant market and draw real investors in. One such Milken vessel was Saul Steinberg, who still owned Reliance Insurance, a giant pool of other people’s money. There were others—Carl Lindner, Meshulam Riklis, Victor Posner—who owned insurance companies and banks whose deposits and premiums they could use to buy junk bonds.
Milken also took advantage of a laxer environment to build pools of capital he would control. For instance, he helped build up an early junk bond mutual fund, First Investors Fund for Income (FIFI), and cultivated a relationship with the fund manager, David Solomon. After Milken got involved, “almost overnight, Solomon was transformed into a seeming portfolio wizard,” wrote investigative reporter Connie Bruck. In those first few years, “Drexel employees claimed it was Milken who pulled Solomon’s strings.” In 1975–1976, FIFI was the most successful bond fund in America, with Solomon and Drexel doing a road show to sell investors on the fund. A few years later, FIFI had so much money from investors that Solomon “could not afford to be choosey” and had to buy “the diciest bonds” Milken had to offer, the “junkiest of the junk.” In the 1980s, with billions of investors’ money, Milken was using FIFI and other captive funds to buy junk bonds Drexel issued. While the First Investors Fund offered seemingly miraculous returns at first, it eventually collapsed, with ordinary investors losing hundreds of millions of dollars, some their life savings.10
The junk bond looked like an active market, with lots of buyers and sellers. But as Akerlof and Romer put it, “The junk bond market of the 1980s was not a thick, anonymous auction market characterized by full revelation of information. To a very great extent, the market owed its existence to a single individual, Michael Milken, who acted, literally, as the auctioneer.”11
Milken spun a theory that he was so good with numbers, such a hard worker, and had discovered that investors undervalued junk bonds due to an irrational preference for quality bonds. This bias seemed to explain the exceptional performance of junk bonds, and how Milken could also seem to find a buyer if a seller wanted out.12 For roughly fifteen years, from 1974 to 1989, Milken got bigger and stronger, and he became a money machine, the junk bond king.
Other investment banks couldn’t figure out how he did what he did. Eventually, they simply started to emulate his aggressive tactics, putting up their own capital to get into junk bonds. But they couldn’t compete, as Akerlof and Romer pointed out, because the market was rigged. Junk bond buyers were confident when they bought Milken’s bonds that they would be paid back. A host of side payments to those running the institutions hiding the losses kept the network functional. Milken’s network—including Milken’s top salesman in Beverly Hills and two Milken-involved thrifts—even quietly purchased an interest in a bond rating company, Duff & Phelps, which then proceeded to rate the bonds of those thrifts favorably (both thrifts eventually collapsed).
Others who tried to compete with Milken by selling junk bonds didn’t have places to stash losses, and were just trying to match lenders and borrowers. If there were defaults, junk bond buyers lost money. So junk bond buyers bought from Milken, who came to control the entire market.13
In 1983, Drexel, which had been a second-tier investment bank, issued $4.69 billion of junk offerings, three times what it had done the year before, including a billion dollars for a young telecommunications upstart named MCI and $400 million for MGM/UA Entertainment Company, entities that could not otherwise access capital markets effectively at the scale they sought. By 1987, the junk bond market had grown from $7 billion in the mid-1970s to $125 billion.14
Looser financial regulation greatly helped Milken, as did lax enforcement of laws that remained on the books. But two changes helped truly super-size Milken’s scheme. The first was the transformation through financial deregulation of the savings and loan industry into giant pools of unregulated government-backed money.
These S&Ls were designed to finance the American home, and Patman had sought to carefully fence them off so they could continue to do so in perpetuity. But they were set loose by a series of laws, including one signed by Carter in 1980 and one signed by Reagan in 1982. S&Ls could now pay depositors any interest rate, and more importantly, they could enter any line of business they wanted, from commercial real estate to junk bonds. And the U.S. taxpayer backed all of it, through deposit insurance.
Across the country, real estate developers took control of S&Ls and began looting them by having the banks make loans to insiders. As they had with Penn Central, accountants looked the other way while the new S&L bosses lied about their balance sheets, and the great law firms, from New York to Chicago to Texas, bullied regulators and threatened suits against them. “For half a million dollars you could buy any legal opinion you wanted from any law firm in New York,” an anonymous lawyer turned banker said in the 1980s.15 Their clients could pay anything for the legal and accounting help, because “deposit insurance gave them the key to the U.S. Treasury.”16
Top politicians on both sides of the aisle, from Republican John McCain to House Democratic leader and former Patman ally Jim Wright, took money from the S&Ls and in turn helped bully regulators. As Banking Committee chair, Patman had fought to preserve the financial channel for homes, and to investigate fraud where he found it. Just six years later, in 1982, Banking Committee chief Fernand St. Germain wrote the bill deregulating Savings and Loans while allegedly being supplied with prostitutes from S&L lobbyists. A few years later, newspapers exposed him as using his power as committee chair to become a millionaire. The scandal caused his popularity to plummet. He fought back, with help from the now-big-business-funded party establishment. His allies ran antiwar ads, accusing his opponent of seeking to bog down the U.S. in Nicaragua, which would become “Another Vietnam.”
Consumer groups meanwhile ignored St. Germain’s corruption because St. Germain criticized bankers for charging high interest rates on credit cards, and offered “trivial but crowd-pleasing bills to regulate unpopular commercial practices.” Congress Watch, a Nader-backed group, said that questions of his personal finances “were unlikely to interfere with his banking work.” Another Nader spin-off, the Public Interest Research Group, practically apologized for noting St. Germain took financial industry money, writing “not everyone who receives a large amount of PAC contributions will be anticonsumer,” and applauding his willingness to put a particular consumer issue “high on the agenda.” St. Germain buried his opponent, surfing to reelection on a flood of business donations, many from large financial institutions.17
A New York Times op-ed satire explained the problem with the 1982 Garn-St. Germain Depository Institutions Act: “We all know now why the old Prudential National Trust company changed its name to Crazy Louie Bank N.A. because by now everybody’s heard the commercials: ‘Shop the banks! Shop the savings banks! Shop the money market funds! Then take your money to Crazy Louie’s. He’ll beat them all! Crazy Louie’s Maniacal Money Account will always pay the highest interest rates in town! And that interest is guaranteed, because Crazy Louie is a member of the FDIC, an agency of the Federal Government, which insures your deposits—not only the principal, but the interest, too.’ ”18
S&L fraud remade the American landscape, funding white elephant shopping centers and luxury hotels built mainly to be looted. The total cost ran into the hundreds of billions of dollars. For Milken, S&Ls were a perfect place to stash losses. When necessary, he could put toxic junk bonds in Columbia Savings and Loan of Beverly Hills, CenTrust Federal Savings of Miami, Executive Life Insurance Company, or any of the more than fifty financial institutions that eventually went bankrupt under the weight of tens of billions of defaulted Drexel bonds.19 As writer Benjamin Stein told Congress, “Thanks largely to well-meant but extremely unfortunate legal changes at the beginning of the 1980s, the federal government basically repealed Glass-Steagall if an investment bank just called its commercial banking captive a ‘savings and loan.’ ”20
Milken now had a virtually unlimited pool of money under his command. He had over a hundred billion dollars in direct financing through junk bonds. More importantly, corporate America and investors believed he could at any point raise as much as needed for any purpose, vastly increasing his power.21 He turned toward the opportunities presented by the relaxation of both anti-merger law and rules surrounding stock market trading. Starting in 1983, Milken staked aggressive corporate raiders and arbitrageurs who would launch raids on companies backed by Drexel junk bonds.22 In 1985, a Drexel banker told the hundreds of assembled financiers that the bank had figured out how to easily “finance the unfriendly takeover,” which earned the conference’s “Predators’ Ball” nickname.23 These bankers looked to Morgan and Mellon as inspiration. A guiding theme of Drexel’s corporate finance department was to find and stake, as one banker put it, the “robber barons of the future.”24
These new raiders looked for a specific type of company. They wanted to buy corporations that generated cash, had little debt, and owned assets. Conservatively managed companies with an engineer-CEO at the helm and that focused on producing industrial goods, such as National Can, were perfect. Then, Milken would find a stalking horse, usually a short, ambitious man who needed to conquer the world. He would either go to his network of junk buyers and raise hundreds of millions of dollars, or write what was called a “highly confident letter” saying that he could do so. The raider would take the money and buy a large slug of shares. Sometimes the company would pay the raider to go away, sometimes the raider would lose to another bidder, and sometimes the raider would win the prize.
If the raider lost, he would still make money by having his shares bought out at higher prices. Carl Icahn earned hundreds of millions this way. If the raider won the company, he would then saddle it with the debt he had incurred. It worked like buying a home with a mortgage. Essentially he would buy the company by borrowing against the company’s own assets. This was a massive leveraging operation, buying corporations with other people’s money. But unlike most attempts to buy stock with borrowed money, there were no margin requirements. Once the acquisition was complete, the company would pay out large salaries, fees, and service the extremely high-cost junk bonds.
Sometimes the companies would go bankrupt and disappear, sometimes the debt would be restructured. It didn’t matter. The deals benefited insiders, who were simply shifting corporate assets to themselves. Fees to the dealmakers, including investment advisors, bankers, underwriters, specialized fund managers participating in the buyouts, and lawyers, came to roughly 6 percent of the purchase price of a firm.25
All of Wall Street changed to accommodate this new and highly profitable activity. Investment bankers and lawyers pioneered a range of tactics to fight against or enact hostile takeovers, colorfully known as “greenmail,” “the PacMan strategy,” “shark repellents,” “the poison pill,” “the golden parachute,” and so forth. But all of these were essentially ways of loading corporate America with debt, or looting the companies outright. Investment bankers were now in the business of selling deals for the fees.
Corporate CEOs, most of whom were initially resistant to the takeover wave, were bribed into submission. In 1977, banker Martin Siegel, who eventually landed at Drexel and, along with Milken, would be criminally convicted, invented the golden parachute. The golden parachute was, as journalist James Stewart put it, “essentially a lucrative employment contract for top corporate officers, [and] provided exorbitant severance payments for the officers in the event of a takeover. Supposedly, the contracts were intended to deter hostile takeovers by making them more expensive. In practice, they tended to make the officers very rich.”26
As important as the fees was the information Milken acquired about which companies were being sold before raiders bid up the price of bonds or stock. This information, as well as deal structures Drexel controlled, gave Milken both money and power. He set up partnership structures outside Drexel, with names like Otter Creek, and allowed favored colleagues and family members to put money into them. These partnerships were then, as sociologist Mary Zey wrote, “used for the purpose of skimming warrants and equities in several of the Drexel underwritings,” such as that of Beatrice Foods.27 Congressman John Dingell found Drexel had twenty to thirty such partnerships allowing employees to profit on the side from deals in which they were involved; Otter Creek held a balance of $145 million, and one account bought and sold a billion dollars of stocks and bonds in a single year.28
According to writer Benjamin Stein, SEC staff attorney John Hewitt was collecting a “mountain of research” about Drexel showing “stupendous price fixing and bond-price rigging” by Milken. There was, he wrote, “clear-cut—or at least impressive—evidence that a Milken partnership, Otter Creek, was trading illegally on inside information.”29 Yet the Reagan Securities and Exchange Commission and Department of Justice had pulled back on enforcement of laws against white-collar crime. While Drexel paid high salaries, it was impossible not to notice the lucrative profits of a Milken partnership. Milken combined allies from inside Drexel and throughout Wall Street into these partnerships, making this entire apparatus dependent on him personally. These partnerships were akin to the House of Morgan’s preferred list, a way to funnel payments by helping favored individuals get guaranteed returns on stock investments. Milken now had yet another lever to control captive pools of capital, whether those were S&Ls, mutual funds, insurance companies, or corporate pensions. He simply showered the men who controlled these pots of other people’s money with an unending stream of favors.
Well-placed speculators could participate in the merger frenzy whether they were involved in the deal or not. Through arbitrage departments, investment bankers could bet on whether a deal would close, and with insider trading tips, these bets would often pay off. Much of Wall Street got involved, directly or indirectly, with Milken’s network. Robert Rubin, who later became the treasury secretary under Bill Clinton, climbed the ladder at Goldman Sachs as an arbitrageur. His protégé, Robert Freeman, accused of being part of the Milken-influenced network of traders, eventually pleaded guilty to insider trading.30
To those around him, it seemed as if Milken had figured out how to grow money on trees, and hand it to his favored clients. In the 1980s, junk bonds became the mechanism for reorganizing corporate America, and brought a new generation of leaders into the forefront of American finance and business with a different philosophy about power. “In a few short years,” wrote pro-Milken journalist Edward Jay Epstein, he “had reshaped the financial world in a way that no one else had done since J. P. Morgan in the nineteenth century.”31
The Predators’ Ball conferences were a celebration of debauchery, money, and power, but they became more than that. They became a celebration of financial capitalism, and an explicit nod to the original robber baron spirit that had created corporate America in the 1880s and 1890s. And they illustrated the increasing political power of this new raider class on Wall Street, not just over their traditional Republican allies, but among the new class of Democrats.
Attendees also included Tim Wirth of Colorado, Bill Bradley of New Jersey, and Alan Cranston of California. Howard Metzenbaum of Ohio, a staunch antimonopolist, went. Ted Kennedy of Massachusetts attended, to “listen and learn.” The mayor of Los Angeles, Tom Bradley, the only African American mayor of the city, gave a speech and introduced Michael Milken as “that man of genius, that man of courage, that man of vision, that man of conviction.”32 These were the young rock stars of the party, the future leaders of America.
The corruption of these politicians was gradual. At first, politicians watched the takeover wave with alarm. Members of Congress introduced over thirty anti-takeover bills.33 The Reagan administration was strongly supportive of the raiders, but Congress wasn’t. Wirth, who chaired an important subcommittee, expressed concern that “shareholders, companies, employees, and entire communities have been harmed in these battles for corporate control.” His key staffer, David Aylward, sought a strong probe and helped organize high-profile hearings. “We really don’t know where this money is coming from, and whether it could be better used for something else in the long term,” he told the press.
Drexel had a lavish political operation. After the hearings, Aylward took a lobbying job working for the Alliance for Capital Access, a trade association of junk bond users. He offered paid speeches to senators and House members, testified before committees, and spread money around. He had become a Milken lobbyist. The congressional push to restrict the use of junk bonds in takeovers ended.34 In 1986, Paul Volcker attempted to impose restrictions on the use of junk bonds. The Reagan administration and Congress pressured him to back down.35
Milken rewarded congressmen directly. As the Los Angeles Times reported, “Two members of Congress, Reps. Stephen L. Neal (D-N.C.) and Carlos J. Moorhead (R-Glendale), were paid $2,000 each in honorariums in 1986 to stroll through the command center of Drexel’s junk bond operation in Beverly Hills and chat with employees.” Neal later spoke on the floor of the House “against provisions in an omnibus spending bill that were designed to discourage the use of junk bonds in financing corporate takeovers.”36
Milken’s money—and takeover fever—spread far and wide within the Democratic Party.37 For instance, in 1990, Carter-era trade representative and former Democratic national chair Robert Strauss received $8 million representing both sides in the acquisition of MCA by Matsushita Electric.38 Strauss’s law firm, Akin, Gump, Strauss, Hauer & Field, had earlier earned $431,058 in 1986 lobbying for Drexel.39
The political machinery of the 1980s Democratic Party was financed in part with Milken money; Drexel executives on the West Coast were responsible for raising between $35,000 and $50,000 apiece for California fundraising events for Tony Coelho, the congressman in charge of making sure that House Democrats kept their majority through the Democratic Congressional Campaign Committee. When Milken had to plead the Fifth Amendment in a committee hearing in Congress so as not to incriminate himself, Coelho remained loyal. At a Drexel conference just a few weeks before Milken testified, Coelho gave a speech in Los Angeles, saying, “I am here tonight to show my respect and deep admiration for Michael Milken, my very good friend.… He is constantly thinking about what can be done to make this a better world.” Coelho got $2,000 for the speech. In 1989, Coelho resigned due to questions about his personal finances. A $100,000 junk bond underwritten by Drexel somehow wound up in his possession, with the bond bought with money borrowed from Columbia Savings and Loan, a thrift run by Milken’s protégé Thomas Spiegel. After Coelho’s resignation from Congress, he went to work on Wall Street for a million dollars a year. “I’m determined to be as successful here as I was in the political world,” he said.40
Meanwhile, arbitrage merger specialist Robert Rubin was everywhere in Democratic politics. He became a close advisor to Democratic presidential hopefuls Walter Mondale and Michael Dukakis and went on to New York governor Mario Cuomo’s competitiveness commission.41
As Milken became more powerful, he became a philosopher-king of the decade. He mimicked the weird political language developed of the era, talking about job formation, education, and “human capital.”
Milken also benefited from Milton Friedman’s success in the 1970s at insisting that the main goal of business leadership should be the well-being of the shareholder. Michael Jensen, a conservative Harvard Business School professor, was a prime conduit and refiner of this thinking, and now argued the takeover wave was essential for attacking entrenched corporate management and restructuring corporations to make them more responsive to shareholders.
Jensen’s theory was that corporate managers had an incentive to run the company inefficiently because shareholders were dispersed and powerless. Jensen saw companies with lots of cash, factories, research departments, and/or unionized workforces as poorly managed. The New Deal–era corporation was, in his view, run by undisciplined non-financially-oriented leaders. One solution was the leveraged buyout firm, a pool of capital run by a financier who could buy these fat and happy companies. A financier would load up these companies with debt and pay out cash dividends, thus, in Jensen’s theory, disciplining corporate management. In reality the leveraged buyout firm was just a mechanism for financiers to loot corporations and strip them of their assets, but Jensen provided a fig leaf useful in the press and on Capitol Hill.
The 1985 Predators’ Ball led to a flurry of dealmaking. Just weeks after the conference, Milken-backed raiders launched takeover bids of Unocal, National Can, Crown Zellerbach, and Northwest Industries.42 The deals got so big that, by the end of the decade, investment bank KKR’s takeover of RJR Nabisco with Drexel debt went for $25 billion, an amount so large that “the electronic transfer of funds necessary to complete the deal exceeded the physical capacity of the Federal Reserve wire transfer.”43 One young Drexel banker half-joked about going after the titans of corporate America, saying “maybe we’ll take a run at IBM.”44
American corporate strategists began to worry about the effects of financiers pillaging corporations. “The hostile tender offer,” said management consulting legend Peter Drucker, “has become a dominant force—many would say the dominant force—in the behavior and actions of American management, and almost certainly a major factor in the erosion of American technological leadership.45
Even corporations that didn’t get taken over restructured to load themselves up with debt. Between 1984 and 1985, 398 of the 950 largest companies in North America restructured, only 52 in response to actual takeover bids. The rest were self-initiated. In 1984, the amount of equity, or the part of the ownership structure that wasn’t debt, shrank by $85 billion. The level of debt in corporate America increased from 73 percent to 81.4 percent just between 1983 and 1984.46
To give a sense of what this did to the American corporation, consider the Goodyear Tire and Rubber Company. In 1986, a British raider named James Goldsmith attacked the company, claiming that management had taken their focus off the tire business. Goldsmith admitted he knew nothing about the tire business, but he did smell cash flow. What was going on was that Goodyear had put too much capital into its tire business, accounting for 25 percent of the research and development of the entire industry. Goodyear was the industry leader, and aimed to stay that way by making ever safer, longer-lasting tires.47
But Goodyear management’s very success made the corporation a target for the raiders, as the one-two combination of low debt and high levels of investment was perfect for looting. The company defended itself. As the head of business planning put it to Congress in the face of Goldsmith’s claims, “I do not believe that our 120,000 employees, tens of thousands of dealers and suppliers, and hundreds of thousands in communities who depend on Goodyear expected anything less than the defense we mounted. We all felt shocked and somewhat helpless in the face of one man backed by billions of dollars raised essentially by pledging our own assets.”
Goodyear defended itself, aggressively, using a “shareholder rights plan.” They sold their energy and aerospace divisions, borrowed money, and bought back their own stock. The shares more than doubled. But in the process, the company took its debt up from 33 percent in 1986 to 80 percent of the total value of the company. Goodyear cut research, capital investment, advertising, training, closed three plants, and reduced employment by 4,300 workers. It had been a well-managed company. There were plant expansions in Alabama in 1976, Tennessee in 1981, and North Carolina in 1982. In 1977, they built a $260 million plant in Oklahoma, and a $250 million plant in Texas to take on Korean competition. But, for three years after the raid, the company announced it would undertake no new investment to “focus on debt repayment.”
“Did we create wealth?” a Goodyear executive wondered later about these years. “I think not. In the long run, I think we destroyed wealth.”48
The junk bond market, and the savings and loan banks, did ultimately collapse. The looting was profound. One analyst noted that nearly all savings and loan banks that were major buyers in the junk bond market collapsed. According to Benjamin Stein, Drexel issued around $220 billion in debt, with a loss to investors and taxpayers of between $40 billion and $100 billion.49 Milken went to jail for insider trading, partly due to his domination of the junk bond market and his unwillingness to share spoils with the rest of Wall Street as much as his own crooked ways. But by the end of the 1980s, Wall Street had permanently changed corporate America. A new type of business model existed. The leveraged buyout industry, stung with bad publicity, rebranded as “private equity.” While some PE firms made productive investments, they were largely pools of floating capital that sought to use the corporation for the purpose of the financier.50
Strategically, the only businesses that were sustainable in the new legal environment were those that could withstand the pressures of financial raiders. Large-scale monopolistic corporations such as General Electric and Walmart could use the new tools to their advantage. So could high-tech concerns such as Microsoft that had taken advantage of the technology revolution to acquire choke holds over new vital arteries of commerce. Private equity firms and financial intermediaries who could use the new capital market structure to their advantage increasingly controlled American business.
In previous eras in American history, the wreckage caused by such widespread looting would have led to substantial legal reforms. And there were some. But the key innovation, that the corporate structure exists as a mechanism for the extraction of cash for insiders from either the company itself or from a market that company monopolized, was here to stay.
This was anything but Wright Patman’s Texas, which traced back to the late nineteenth century and the Farmers’ Alliance demands for low interest rates and fair markets. J. R.’s Texas culture was formed in the 1940s, with billionaire financiers in short sleeves play-acting cowboy on Wall Street, as captured in books with titles such as The Lusty Texans of Dallas, Houston: Land of the Big Rich, and The Super-Americans. By the 1980s, it was no longer just Texas oil fraud, but Texas land fraud and Texas savings and loan fraud that minted the new millionaires.
After the Iranian revolution in 1979, the skyrocketing of the prices of oil resulted in one of the largest transfers of wealth in history, from oil consumers in the West to oil producers. No one but Arabs, Venezuelans, and Texans seemed to be doing well. The stock market was catatonic, inflation and interest rates catastrophic. In such an environment, the Federal Reserve couldn’t even really print money without stoking more inflation. But the Texans and the Saudis could always pump more oil.
The new culture of greed in the oil patch reverberated across America, and around the world. The 1980 episode of Dallas “Who shot J. R.?” was the second-highest-rated prime time show in American history. The mother of the Queen of England begged Larry Hagman to tell her who did it. He refused. Hagman later claimed that the show, broadcast in communist Romania, helped bring down the country’s dictator by illustrating to the forlorn people the luxuries available in the West.
Hagman was a special guest at the 1986 party of the biggest names on Wall Street, nicknamed the “Predators’ Ball.” More formally, it was called the “Drexel High-Yield Bond Department Annual Conference,” high-yield debt being the preferred name for junk bonds. Dallas and J. R. were a perfect bridge between the oil-shock-driven 1970s and the “Greed is good” Wall Street–oriented decade of the 1980s.
The gathered wealth represented, according to one participant, three times the GNP of the U.S.2 So powerful was this combination of financial firepower and lax merger rules that the Predators’ Ball—held annually and increasing in prestige until the end of the decade—became a forum for thousands of the most important people in finance, as well as those trying to peek into this world of luxury. Attendees included oil magnate and corporate raider T. Boone Pickens, media barons Rupert Murdoch, Barry Diller, and Ted Turner, cell phone pioneer Craig McCaw, financial kingpin Ronald Perelman, revolutionary corporate raiders Carl Icahn and Henry Kravis, Las Vegas casino magnate Steve Wynn, and countless CEOs, celebrities, and politicians, as well as striking workers to picket them.3
By 1986, the conference had become an orgy of fame, money, sex, arbitrage, politics, and mergers. Frank Sinatra once made an appearance for a cool $150,000 fee. Diana Ross sang, changing outfits twice during her routine.4 Country music star Dolly Parton performed. A Madonna look-alike danced and lip-synced to her famous song “Material Girl,” changing the lyrics to “I’m a double-B girl living in a material world,” in a nod to both bra sizes and junk bond ratings.5
On the second night, the VIPs of the event, some hundred of the “real players”—people with large amounts of money, access to money, or deal lawyers—attended a private party and dinner. Arbitrageur Martin Weinstein made a wry comment, noting that a corporate raider named Irwin Jacobs “had been in deep conversation for hours with one of these women at the far end of the room.” Weinstein said, “Tell Irwin he doesn’t have to work so hard. She’s already paid for.”6
Such was life among financial raiders, schemers, looters, and fraudsters of the 1980s who were not content with yachts and private jets, but sought entire corporations to fit into burgeoning industrial empires. The investment bank Drexel Burnham Lambert was the center of the swirling greed, the industry leader and near monopolist of the corporate restructuring of the 1980s. And Drexel was run in all but name by the most influential banker on Wall Street since Andrew Mellon: Michael Milken. The J. R. Ewing sketch was Milken’s doing. It was symbolism, and potent, at that.
Milken represented the return of the final component of Mellonism, the unbridled power of the financier to shape the real economy to serve his own ends. Milken used the corporation and the bank as a means of moving investors’ capital—other people’s money—into his own pocket. Unlike Saul Steinberg in the 1960s, Milken was free from restrictions on financial capital, and free from antitrust rules or banking regulations. He could use borrowed money or trading instruments however he saw fit.
Milken got his start in 1969, entering a second-tier Wall Street firm as a trader in bonds of high-risk companies. Because the bonds Milken traded were risky, they paid a high interest rate. Often these were companies known as “fallen angels” that had been considered good credit risks, like Penn Central, but had defaulted. There was no public listing for these bonds, which Wall Street soon dubbed “junk bonds.” In the 1970s, most of the midlevel investment banks that raised money for these kinds of firms disappeared, leaving a funding gap for smaller and younger companies.7
Smaller and medium-sized companies presented a special challenge for financial markets. For one, they didn’t have enough of a reputation or track record that investors could rely on. These kinds of companies typically borrowed money via direct lending through banks. A banker could monitor a company directly, unlike atomized investors who held small bits of these corporations’ paper. But as banking declined in importance versus the increasingly unregulated financial system, so did the financing channels for newer and riskier ventures.
In another era, Milken would have become a modestly successful specialist in a backwater area of Wall Street, or perhaps a small-scale white-collar crook. But Milken would take advantage of, and pushed, the newly lax legal context for finance. There was another risk in lending to unknown, lesser known, or weaker companies without adequate supervision. This kind of lending could be easily corrupted. Two economists, George Akerlof and Paul Romer, observed the danger. As they put it in 1993, a “limited liability corporation could borrow money, pay it into the private account of the owners, and then default on its debt.”8 This danger was especially acute when the person in charge of lending the money was in on the scam. He or she could get money from investors, “lend” it to unknown companies, and then transfer the money to his or her own pocket by taking a cut. New Deal financial reforms were designed to block just such behavior, which had been done by the financiers of the 1920s.
Michael Milken became the architect of a complex and corrupt financial system based on engaging in this kind of looting. It started relatively small. He would entice investors into buying junk bonds of unknown companies that yielded high interest, and then take large fees from the deal flow. Milken had to ensure that these bonds paid out their interest, or at the very least, that investors who held these bonds could sell them in a market. Otherwise, investors would stop buying junk.
Milken somehow made this work by standing in between the junk bond buyer and the company issuing the debt. If you bought Drexel junk, Milken would always be willing to buy back your bonds, no matter how the underlying corporation that issued the bonds did. Somehow, even if the bond was outlandishly risky or close to worthless, Milken could always find a willing buyer, or take you out of it himself. Bond buying is a form of lending, and, normally, bond buyers care about whether the borrower will pay them back. But Milken stood in the middle between a lender and a borrower, and would ensure bond buyers were paid back regardless of how the borrower did. He could do this because he was stashing losses within captive pools of capital he controlled, like mutual funds, insurance companies, thrifts, and pension funds, aka other people’s money.9
But who were these buyers willing to buy worthless junk bonds? Milken realized he needed to find men who controlled pools of other people’s money and who were willing to hide losses for him. He found them among the dregs of Wall Street, the scam artists who lived in the gray areas of the financial world. These men wanted access to junk bond financing, so they had an incentive to help Milken create what looked like a vibrant market and draw real investors in. One such Milken vessel was Saul Steinberg, who still owned Reliance Insurance, a giant pool of other people’s money. There were others—Carl Lindner, Meshulam Riklis, Victor Posner—who owned insurance companies and banks whose deposits and premiums they could use to buy junk bonds.
Milken also took advantage of a laxer environment to build pools of capital he would control. For instance, he helped build up an early junk bond mutual fund, First Investors Fund for Income (FIFI), and cultivated a relationship with the fund manager, David Solomon. After Milken got involved, “almost overnight, Solomon was transformed into a seeming portfolio wizard,” wrote investigative reporter Connie Bruck. In those first few years, “Drexel employees claimed it was Milken who pulled Solomon’s strings.” In 1975–1976, FIFI was the most successful bond fund in America, with Solomon and Drexel doing a road show to sell investors on the fund. A few years later, FIFI had so much money from investors that Solomon “could not afford to be choosey” and had to buy “the diciest bonds” Milken had to offer, the “junkiest of the junk.” In the 1980s, with billions of investors’ money, Milken was using FIFI and other captive funds to buy junk bonds Drexel issued. While the First Investors Fund offered seemingly miraculous returns at first, it eventually collapsed, with ordinary investors losing hundreds of millions of dollars, some their life savings.10
The junk bond looked like an active market, with lots of buyers and sellers. But as Akerlof and Romer put it, “The junk bond market of the 1980s was not a thick, anonymous auction market characterized by full revelation of information. To a very great extent, the market owed its existence to a single individual, Michael Milken, who acted, literally, as the auctioneer.”11
Milken spun a theory that he was so good with numbers, such a hard worker, and had discovered that investors undervalued junk bonds due to an irrational preference for quality bonds. This bias seemed to explain the exceptional performance of junk bonds, and how Milken could also seem to find a buyer if a seller wanted out.12 For roughly fifteen years, from 1974 to 1989, Milken got bigger and stronger, and he became a money machine, the junk bond king.
Other investment banks couldn’t figure out how he did what he did. Eventually, they simply started to emulate his aggressive tactics, putting up their own capital to get into junk bonds. But they couldn’t compete, as Akerlof and Romer pointed out, because the market was rigged. Junk bond buyers were confident when they bought Milken’s bonds that they would be paid back. A host of side payments to those running the institutions hiding the losses kept the network functional. Milken’s network—including Milken’s top salesman in Beverly Hills and two Milken-involved thrifts—even quietly purchased an interest in a bond rating company, Duff & Phelps, which then proceeded to rate the bonds of those thrifts favorably (both thrifts eventually collapsed).
Others who tried to compete with Milken by selling junk bonds didn’t have places to stash losses, and were just trying to match lenders and borrowers. If there were defaults, junk bond buyers lost money. So junk bond buyers bought from Milken, who came to control the entire market.13
In 1983, Drexel, which had been a second-tier investment bank, issued $4.69 billion of junk offerings, three times what it had done the year before, including a billion dollars for a young telecommunications upstart named MCI and $400 million for MGM/UA Entertainment Company, entities that could not otherwise access capital markets effectively at the scale they sought. By 1987, the junk bond market had grown from $7 billion in the mid-1970s to $125 billion.14
Looser financial regulation greatly helped Milken, as did lax enforcement of laws that remained on the books. But two changes helped truly super-size Milken’s scheme. The first was the transformation through financial deregulation of the savings and loan industry into giant pools of unregulated government-backed money.
These S&Ls were designed to finance the American home, and Patman had sought to carefully fence them off so they could continue to do so in perpetuity. But they were set loose by a series of laws, including one signed by Carter in 1980 and one signed by Reagan in 1982. S&Ls could now pay depositors any interest rate, and more importantly, they could enter any line of business they wanted, from commercial real estate to junk bonds. And the U.S. taxpayer backed all of it, through deposit insurance.
Across the country, real estate developers took control of S&Ls and began looting them by having the banks make loans to insiders. As they had with Penn Central, accountants looked the other way while the new S&L bosses lied about their balance sheets, and the great law firms, from New York to Chicago to Texas, bullied regulators and threatened suits against them. “For half a million dollars you could buy any legal opinion you wanted from any law firm in New York,” an anonymous lawyer turned banker said in the 1980s.15 Their clients could pay anything for the legal and accounting help, because “deposit insurance gave them the key to the U.S. Treasury.”16
Top politicians on both sides of the aisle, from Republican John McCain to House Democratic leader and former Patman ally Jim Wright, took money from the S&Ls and in turn helped bully regulators. As Banking Committee chair, Patman had fought to preserve the financial channel for homes, and to investigate fraud where he found it. Just six years later, in 1982, Banking Committee chief Fernand St. Germain wrote the bill deregulating Savings and Loans while allegedly being supplied with prostitutes from S&L lobbyists. A few years later, newspapers exposed him as using his power as committee chair to become a millionaire. The scandal caused his popularity to plummet. He fought back, with help from the now-big-business-funded party establishment. His allies ran antiwar ads, accusing his opponent of seeking to bog down the U.S. in Nicaragua, which would become “Another Vietnam.”
Consumer groups meanwhile ignored St. Germain’s corruption because St. Germain criticized bankers for charging high interest rates on credit cards, and offered “trivial but crowd-pleasing bills to regulate unpopular commercial practices.” Congress Watch, a Nader-backed group, said that questions of his personal finances “were unlikely to interfere with his banking work.” Another Nader spin-off, the Public Interest Research Group, practically apologized for noting St. Germain took financial industry money, writing “not everyone who receives a large amount of PAC contributions will be anticonsumer,” and applauding his willingness to put a particular consumer issue “high on the agenda.” St. Germain buried his opponent, surfing to reelection on a flood of business donations, many from large financial institutions.17
A New York Times op-ed satire explained the problem with the 1982 Garn-St. Germain Depository Institutions Act: “We all know now why the old Prudential National Trust company changed its name to Crazy Louie Bank N.A. because by now everybody’s heard the commercials: ‘Shop the banks! Shop the savings banks! Shop the money market funds! Then take your money to Crazy Louie’s. He’ll beat them all! Crazy Louie’s Maniacal Money Account will always pay the highest interest rates in town! And that interest is guaranteed, because Crazy Louie is a member of the FDIC, an agency of the Federal Government, which insures your deposits—not only the principal, but the interest, too.’ ”18
S&L fraud remade the American landscape, funding white elephant shopping centers and luxury hotels built mainly to be looted. The total cost ran into the hundreds of billions of dollars. For Milken, S&Ls were a perfect place to stash losses. When necessary, he could put toxic junk bonds in Columbia Savings and Loan of Beverly Hills, CenTrust Federal Savings of Miami, Executive Life Insurance Company, or any of the more than fifty financial institutions that eventually went bankrupt under the weight of tens of billions of defaulted Drexel bonds.19 As writer Benjamin Stein told Congress, “Thanks largely to well-meant but extremely unfortunate legal changes at the beginning of the 1980s, the federal government basically repealed Glass-Steagall if an investment bank just called its commercial banking captive a ‘savings and loan.’ ”20
Milken now had a virtually unlimited pool of money under his command. He had over a hundred billion dollars in direct financing through junk bonds. More importantly, corporate America and investors believed he could at any point raise as much as needed for any purpose, vastly increasing his power.21 He turned toward the opportunities presented by the relaxation of both anti-merger law and rules surrounding stock market trading. Starting in 1983, Milken staked aggressive corporate raiders and arbitrageurs who would launch raids on companies backed by Drexel junk bonds.22 In 1985, a Drexel banker told the hundreds of assembled financiers that the bank had figured out how to easily “finance the unfriendly takeover,” which earned the conference’s “Predators’ Ball” nickname.23 These bankers looked to Morgan and Mellon as inspiration. A guiding theme of Drexel’s corporate finance department was to find and stake, as one banker put it, the “robber barons of the future.”24
These new raiders looked for a specific type of company. They wanted to buy corporations that generated cash, had little debt, and owned assets. Conservatively managed companies with an engineer-CEO at the helm and that focused on producing industrial goods, such as National Can, were perfect. Then, Milken would find a stalking horse, usually a short, ambitious man who needed to conquer the world. He would either go to his network of junk buyers and raise hundreds of millions of dollars, or write what was called a “highly confident letter” saying that he could do so. The raider would take the money and buy a large slug of shares. Sometimes the company would pay the raider to go away, sometimes the raider would lose to another bidder, and sometimes the raider would win the prize.
If the raider lost, he would still make money by having his shares bought out at higher prices. Carl Icahn earned hundreds of millions this way. If the raider won the company, he would then saddle it with the debt he had incurred. It worked like buying a home with a mortgage. Essentially he would buy the company by borrowing against the company’s own assets. This was a massive leveraging operation, buying corporations with other people’s money. But unlike most attempts to buy stock with borrowed money, there were no margin requirements. Once the acquisition was complete, the company would pay out large salaries, fees, and service the extremely high-cost junk bonds.
Sometimes the companies would go bankrupt and disappear, sometimes the debt would be restructured. It didn’t matter. The deals benefited insiders, who were simply shifting corporate assets to themselves. Fees to the dealmakers, including investment advisors, bankers, underwriters, specialized fund managers participating in the buyouts, and lawyers, came to roughly 6 percent of the purchase price of a firm.25
All of Wall Street changed to accommodate this new and highly profitable activity. Investment bankers and lawyers pioneered a range of tactics to fight against or enact hostile takeovers, colorfully known as “greenmail,” “the PacMan strategy,” “shark repellents,” “the poison pill,” “the golden parachute,” and so forth. But all of these were essentially ways of loading corporate America with debt, or looting the companies outright. Investment bankers were now in the business of selling deals for the fees.
Corporate CEOs, most of whom were initially resistant to the takeover wave, were bribed into submission. In 1977, banker Martin Siegel, who eventually landed at Drexel and, along with Milken, would be criminally convicted, invented the golden parachute. The golden parachute was, as journalist James Stewart put it, “essentially a lucrative employment contract for top corporate officers, [and] provided exorbitant severance payments for the officers in the event of a takeover. Supposedly, the contracts were intended to deter hostile takeovers by making them more expensive. In practice, they tended to make the officers very rich.”26
As important as the fees was the information Milken acquired about which companies were being sold before raiders bid up the price of bonds or stock. This information, as well as deal structures Drexel controlled, gave Milken both money and power. He set up partnership structures outside Drexel, with names like Otter Creek, and allowed favored colleagues and family members to put money into them. These partnerships were then, as sociologist Mary Zey wrote, “used for the purpose of skimming warrants and equities in several of the Drexel underwritings,” such as that of Beatrice Foods.27 Congressman John Dingell found Drexel had twenty to thirty such partnerships allowing employees to profit on the side from deals in which they were involved; Otter Creek held a balance of $145 million, and one account bought and sold a billion dollars of stocks and bonds in a single year.28
According to writer Benjamin Stein, SEC staff attorney John Hewitt was collecting a “mountain of research” about Drexel showing “stupendous price fixing and bond-price rigging” by Milken. There was, he wrote, “clear-cut—or at least impressive—evidence that a Milken partnership, Otter Creek, was trading illegally on inside information.”29 Yet the Reagan Securities and Exchange Commission and Department of Justice had pulled back on enforcement of laws against white-collar crime. While Drexel paid high salaries, it was impossible not to notice the lucrative profits of a Milken partnership. Milken combined allies from inside Drexel and throughout Wall Street into these partnerships, making this entire apparatus dependent on him personally. These partnerships were akin to the House of Morgan’s preferred list, a way to funnel payments by helping favored individuals get guaranteed returns on stock investments. Milken now had yet another lever to control captive pools of capital, whether those were S&Ls, mutual funds, insurance companies, or corporate pensions. He simply showered the men who controlled these pots of other people’s money with an unending stream of favors.
Well-placed speculators could participate in the merger frenzy whether they were involved in the deal or not. Through arbitrage departments, investment bankers could bet on whether a deal would close, and with insider trading tips, these bets would often pay off. Much of Wall Street got involved, directly or indirectly, with Milken’s network. Robert Rubin, who later became the treasury secretary under Bill Clinton, climbed the ladder at Goldman Sachs as an arbitrageur. His protégé, Robert Freeman, accused of being part of the Milken-influenced network of traders, eventually pleaded guilty to insider trading.30
To those around him, it seemed as if Milken had figured out how to grow money on trees, and hand it to his favored clients. In the 1980s, junk bonds became the mechanism for reorganizing corporate America, and brought a new generation of leaders into the forefront of American finance and business with a different philosophy about power. “In a few short years,” wrote pro-Milken journalist Edward Jay Epstein, he “had reshaped the financial world in a way that no one else had done since J. P. Morgan in the nineteenth century.”31
The Predators’ Ball conferences were a celebration of debauchery, money, and power, but they became more than that. They became a celebration of financial capitalism, and an explicit nod to the original robber baron spirit that had created corporate America in the 1880s and 1890s. And they illustrated the increasing political power of this new raider class on Wall Street, not just over their traditional Republican allies, but among the new class of Democrats.
Attendees also included Tim Wirth of Colorado, Bill Bradley of New Jersey, and Alan Cranston of California. Howard Metzenbaum of Ohio, a staunch antimonopolist, went. Ted Kennedy of Massachusetts attended, to “listen and learn.” The mayor of Los Angeles, Tom Bradley, the only African American mayor of the city, gave a speech and introduced Michael Milken as “that man of genius, that man of courage, that man of vision, that man of conviction.”32 These were the young rock stars of the party, the future leaders of America.
The corruption of these politicians was gradual. At first, politicians watched the takeover wave with alarm. Members of Congress introduced over thirty anti-takeover bills.33 The Reagan administration was strongly supportive of the raiders, but Congress wasn’t. Wirth, who chaired an important subcommittee, expressed concern that “shareholders, companies, employees, and entire communities have been harmed in these battles for corporate control.” His key staffer, David Aylward, sought a strong probe and helped organize high-profile hearings. “We really don’t know where this money is coming from, and whether it could be better used for something else in the long term,” he told the press.
Drexel had a lavish political operation. After the hearings, Aylward took a lobbying job working for the Alliance for Capital Access, a trade association of junk bond users. He offered paid speeches to senators and House members, testified before committees, and spread money around. He had become a Milken lobbyist. The congressional push to restrict the use of junk bonds in takeovers ended.34 In 1986, Paul Volcker attempted to impose restrictions on the use of junk bonds. The Reagan administration and Congress pressured him to back down.35
Milken rewarded congressmen directly. As the Los Angeles Times reported, “Two members of Congress, Reps. Stephen L. Neal (D-N.C.) and Carlos J. Moorhead (R-Glendale), were paid $2,000 each in honorariums in 1986 to stroll through the command center of Drexel’s junk bond operation in Beverly Hills and chat with employees.” Neal later spoke on the floor of the House “against provisions in an omnibus spending bill that were designed to discourage the use of junk bonds in financing corporate takeovers.”36
Milken’s money—and takeover fever—spread far and wide within the Democratic Party.37 For instance, in 1990, Carter-era trade representative and former Democratic national chair Robert Strauss received $8 million representing both sides in the acquisition of MCA by Matsushita Electric.38 Strauss’s law firm, Akin, Gump, Strauss, Hauer & Field, had earlier earned $431,058 in 1986 lobbying for Drexel.39
The political machinery of the 1980s Democratic Party was financed in part with Milken money; Drexel executives on the West Coast were responsible for raising between $35,000 and $50,000 apiece for California fundraising events for Tony Coelho, the congressman in charge of making sure that House Democrats kept their majority through the Democratic Congressional Campaign Committee. When Milken had to plead the Fifth Amendment in a committee hearing in Congress so as not to incriminate himself, Coelho remained loyal. At a Drexel conference just a few weeks before Milken testified, Coelho gave a speech in Los Angeles, saying, “I am here tonight to show my respect and deep admiration for Michael Milken, my very good friend.… He is constantly thinking about what can be done to make this a better world.” Coelho got $2,000 for the speech. In 1989, Coelho resigned due to questions about his personal finances. A $100,000 junk bond underwritten by Drexel somehow wound up in his possession, with the bond bought with money borrowed from Columbia Savings and Loan, a thrift run by Milken’s protégé Thomas Spiegel. After Coelho’s resignation from Congress, he went to work on Wall Street for a million dollars a year. “I’m determined to be as successful here as I was in the political world,” he said.40
Meanwhile, arbitrage merger specialist Robert Rubin was everywhere in Democratic politics. He became a close advisor to Democratic presidential hopefuls Walter Mondale and Michael Dukakis and went on to New York governor Mario Cuomo’s competitiveness commission.41
As Milken became more powerful, he became a philosopher-king of the decade. He mimicked the weird political language developed of the era, talking about job formation, education, and “human capital.”
Milken also benefited from Milton Friedman’s success in the 1970s at insisting that the main goal of business leadership should be the well-being of the shareholder. Michael Jensen, a conservative Harvard Business School professor, was a prime conduit and refiner of this thinking, and now argued the takeover wave was essential for attacking entrenched corporate management and restructuring corporations to make them more responsive to shareholders.
Jensen’s theory was that corporate managers had an incentive to run the company inefficiently because shareholders were dispersed and powerless. Jensen saw companies with lots of cash, factories, research departments, and/or unionized workforces as poorly managed. The New Deal–era corporation was, in his view, run by undisciplined non-financially-oriented leaders. One solution was the leveraged buyout firm, a pool of capital run by a financier who could buy these fat and happy companies. A financier would load up these companies with debt and pay out cash dividends, thus, in Jensen’s theory, disciplining corporate management. In reality the leveraged buyout firm was just a mechanism for financiers to loot corporations and strip them of their assets, but Jensen provided a fig leaf useful in the press and on Capitol Hill.
The 1985 Predators’ Ball led to a flurry of dealmaking. Just weeks after the conference, Milken-backed raiders launched takeover bids of Unocal, National Can, Crown Zellerbach, and Northwest Industries.42 The deals got so big that, by the end of the decade, investment bank KKR’s takeover of RJR Nabisco with Drexel debt went for $25 billion, an amount so large that “the electronic transfer of funds necessary to complete the deal exceeded the physical capacity of the Federal Reserve wire transfer.”43 One young Drexel banker half-joked about going after the titans of corporate America, saying “maybe we’ll take a run at IBM.”44
American corporate strategists began to worry about the effects of financiers pillaging corporations. “The hostile tender offer,” said management consulting legend Peter Drucker, “has become a dominant force—many would say the dominant force—in the behavior and actions of American management, and almost certainly a major factor in the erosion of American technological leadership.45
Even corporations that didn’t get taken over restructured to load themselves up with debt. Between 1984 and 1985, 398 of the 950 largest companies in North America restructured, only 52 in response to actual takeover bids. The rest were self-initiated. In 1984, the amount of equity, or the part of the ownership structure that wasn’t debt, shrank by $85 billion. The level of debt in corporate America increased from 73 percent to 81.4 percent just between 1983 and 1984.46
To give a sense of what this did to the American corporation, consider the Goodyear Tire and Rubber Company. In 1986, a British raider named James Goldsmith attacked the company, claiming that management had taken their focus off the tire business. Goldsmith admitted he knew nothing about the tire business, but he did smell cash flow. What was going on was that Goodyear had put too much capital into its tire business, accounting for 25 percent of the research and development of the entire industry. Goodyear was the industry leader, and aimed to stay that way by making ever safer, longer-lasting tires.47
But Goodyear management’s very success made the corporation a target for the raiders, as the one-two combination of low debt and high levels of investment was perfect for looting. The company defended itself. As the head of business planning put it to Congress in the face of Goldsmith’s claims, “I do not believe that our 120,000 employees, tens of thousands of dealers and suppliers, and hundreds of thousands in communities who depend on Goodyear expected anything less than the defense we mounted. We all felt shocked and somewhat helpless in the face of one man backed by billions of dollars raised essentially by pledging our own assets.”
Goodyear defended itself, aggressively, using a “shareholder rights plan.” They sold their energy and aerospace divisions, borrowed money, and bought back their own stock. The shares more than doubled. But in the process, the company took its debt up from 33 percent in 1986 to 80 percent of the total value of the company. Goodyear cut research, capital investment, advertising, training, closed three plants, and reduced employment by 4,300 workers. It had been a well-managed company. There were plant expansions in Alabama in 1976, Tennessee in 1981, and North Carolina in 1982. In 1977, they built a $260 million plant in Oklahoma, and a $250 million plant in Texas to take on Korean competition. But, for three years after the raid, the company announced it would undertake no new investment to “focus on debt repayment.”
“Did we create wealth?” a Goodyear executive wondered later about these years. “I think not. In the long run, I think we destroyed wealth.”48
The junk bond market, and the savings and loan banks, did ultimately collapse. The looting was profound. One analyst noted that nearly all savings and loan banks that were major buyers in the junk bond market collapsed. According to Benjamin Stein, Drexel issued around $220 billion in debt, with a loss to investors and taxpayers of between $40 billion and $100 billion.49 Milken went to jail for insider trading, partly due to his domination of the junk bond market and his unwillingness to share spoils with the rest of Wall Street as much as his own crooked ways. But by the end of the 1980s, Wall Street had permanently changed corporate America. A new type of business model existed. The leveraged buyout industry, stung with bad publicity, rebranded as “private equity.” While some PE firms made productive investments, they were largely pools of floating capital that sought to use the corporation for the purpose of the financier.50
Strategically, the only businesses that were sustainable in the new legal environment were those that could withstand the pressures of financial raiders. Large-scale monopolistic corporations such as General Electric and Walmart could use the new tools to their advantage. So could high-tech concerns such as Microsoft that had taken advantage of the technology revolution to acquire choke holds over new vital arteries of commerce. Private equity firms and financial intermediaries who could use the new capital market structure to their advantage increasingly controlled American business.
In previous eras in American history, the wreckage caused by such widespread looting would have led to substantial legal reforms. And there were some. But the key innovation, that the corporate structure exists as a mechanism for the extraction of cash for insiders from either the company itself or from a market that company monopolized, was here to stay.
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