Street Speculator

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Michael Milken was well-known in the 1980’s as the man to see if your company needed to raise capital. Milken headed the bond department in the California office of investment bank Drexel Burnham Lambert.

Milken was arguably responsible for creating the market for high yield securities (Or what is known as “JUNK BONDS”). These securities were called “Junk” because there was a very high risk of default. The interest rate on these bonds were high. The companies who issued them were seen as not having the ability to repay due to weak balance sheets or low credit rating .

Milken’s analysis of these companies stated otherwise and this is where his troubles began. Many would argue that Mike Milken knew some of these institutions had no possible means of repaying these bonds to the investors. But as the consummate salesman, Milken would portray these securities as no more risky than U.S. Treasury bonds, but offered a higher yield and the potential of higher returns on investment.

ONE HAND WASHES THE OTHER

Once Milken would raise capital for a company, he would then expect this company to purchase the bonds of subsequent companies where Drexel was the underwriter. His investment circle included Insurance companies, Savings and Loans (S&L’s), and even mutual funds. This cartel-like group participated in the trading of the bonds of companies Milken would bring to the market on a primary and secondary marketplace. There was a sense of unfettered loyalty amongst them all.

As long as Milken had buyers for his bond issues he would continue to generate enormous fees. I believe Drexel Burnham would receive up to 10% of each bond issue. For example, if Milken would raise $200 million for a company, Drexel would receive $20 million. In 1986, Milken is said to have made over $500 million (personally), which included bonuses.

WHAT WE COULD NOT SEE

It was later discovered that this money machine was nothing more than a well refined ponzi scheme, like Social Security. When a particular company would default on his bond debt, Milken would just refinance and issue more debt. With a refinance, Milken and Drexel would still receive its fees for raising the money or in finance terms, RECAPITALIZATION.

Milken would later raise capital for so-called corporate raiders such as Carl Icahn, Boone Pickens, and others. There was nothing wrong with this. It became an issue, a legal issue rather when Milken started purchasing stock in companies he knew would become takeover or potential takeover targets. This is what is known as INSIDER TRADING.

Milken was eventually charged with Insider Trading along with 70+ other federal securities violations. He was sentenced to 10 years in prison of which he served about 18 months. He also paid up to $1 billion in fines and civil penalties.

SUBPRIME v. JUNK BOND era

Milken was said to have raised debt capital for companies whom he known or should have known had a very high potential of default. In the current credit crisis due to subprime lending, many banks and mortgage brokers are said to have placed borrowers into loan products where they knew the borrower would not be able to pay back. Now we have a high mortgage default rate just as the high rate of high yield bond defaults in the late 80’s and early 90’s.

Is Michael Milken to blame? This argument is one that many people present. In the Milken era, a large number of S&L’s and insurance companies went out of business as they held large portfolios of Milken “JUNK”. Now many financial institutions are either going out of business or having to raise capital to stay afloat (Bear Sterns, Lehman Brothers, Merrill Lynch, Wachovia, etc…).

You can further your research on Michael Milken and what he did for the capital markets by reading the following books:

Den of Thieves by James Stewart

A License to Steal by Ben Stein

The Predators’ Ball by Connie Bruck

In closing, I personally look at Milken as a rather intriguing individual. From the information I gathered it seems he started with good intentions and then greed started to control his decision-making. He now focuses his time and energy on education through the Milken Family Foundation (which gives an annual Teacher Award), providing funding to research the cure for prostate cancer (Milken is a prostate cancer survivor), and to global finance through the Milken Institute (www.milkeninstitute.com) which holds an annual conference featuring some of the worlds best known business leaders and innovators.

On another positive, Milken did raise money for the following companies and individuals whom are still in existence:

TED TURNER- Turner Broadcasting (CNN)

STEVE WYNN- (Wynn Resorts)

RUPERT MURDOCH- (News Corp.)