Casino Mentality
The Federal Reserve Board has proposed a useful if modest regulation of high-yield bonds, the so-called junk bonds, as they are used to finance corporate takeovers. It is a good first step in addressing the growing evidence of abuses and dangerous debt accumulation in the frenzied world of acquisitions.
Under the new regulations, junk bonds would be subject to the margin rule that already applies to stock purchases, limiting to 50% of the purchase the amount of money that can be borrowed against stock. Extension of this rule to the shell companies, created for leveraged buy-outs and takeovers, would at least serve as a damper on the issuance of these “non-investment-grade securities.”
The regulation is opposed by the Reagan Administration on the ground that the marketplace is working well enough and requires no government intervention. And it is opposed by practitioners of the takeover art--notably Drexel Burnham Lambert Inc., a Wall Street investment firm specializing in so-called junk bonds for corporate takeovers.
But a majority of the Federal Reserve Board--including the chairman, Paul A. Volcker--have concluded that some tightening is required. They are right.
“The shell corporation got to be a very obvious evasion of the margin regulations, and we ought to do something,” Michael Bradfield, general counsel of the board, told the New York Times.
Millions of dollars are changing hands in the transactions. More than 800 tender offers or mergers have been announced this year, with a value estimated at about $160 billion. Lawyers and investment firms received $100 million for services in just one of these.
This ominous diversion of vast resources to takeovers and, presumably, away from the generation of productive new capacity in the economy is troubling. There has been a hesitancy to interfere, however, because the threat of a takeover can serve to reform weak managements, and in some cases takeovers can correct what has been the neglect of stockholders’ interests. The effect of the new Federal Reserve rule would respect the importance of caution. It would be limited to only one dimension of the broader takeover problem, but it would nevertheless be an appropriate response to the problem of rising corporate debt and the increasing risk of what Volcker has called the “reduction in the financial strength of business firms.”
The takeover fever is an element of a broader problem affecting the American economy. The problem is a preoccupation with short-term performance at the expense of long-term productivity. Trading is dominated by these short-term considerations, with major money managers, including those responsible for billions in pension funds, playing as if there were no day after tomorrow. That desperate emphasis on the next quarter’s returns reinforces bad management practices as it also encourages diversions of money into takeovers of existing plants rather than into capital formation. So the securities markets are open to the charge that they are getting to be more like casinos than economy-based financial institutions.
Fundamental reform of the casino mentality probably is beyond the power of government. But the Federal Reserve move will at least eliminate an inequity that has proved to be an incentive to unproductive investment.
