The Junk-Bond King’s Next Move : Mike Milken Revolutionized Wall Street. Now, in the Face of Insider-Trading Investigations, the Beverly Hills Capitalist Explains His Next Assault on the World of High Finance.
At 4:30 A. M. a MERCEDES pulls up behind Gump’s department store in Beverly Hills--as it does every weekday--and a boyish-looking man with an angular face gets out, toting two dogeared canvas bags full of documents and reports. Under the watchful eye of his bodyguard, he takes the elevator to the fourth-floor trading room of Drexel Burnham Lambert. He then slips into his slot at the center of the large X-shaped desk occupied by a dozen other traders. He is Michael Robert Milken, and although he is nominally just the head of this small branch office, he is arguably the most powerful and feared financier in America since World War II.
Milken, a man who has been called “the Oral Roberts of junk bonds” and “Milken the Magnificent” in the financial press and who in less than 10 years expanded a small, largely ignored investment market--junk bonds--to an astounding $125-billion capital market, remains invisible to the world outside; he shuns social functions and until recently has refused press interviews. But on the advice of his lawyer, Edward Bennett Williams, Milken has now, in interviews over the course of nearly two months, emerged from his previous anonymity. The following is Milken’s view of his world--where, on the one hand, he may soon be indicted in the widening insider-trading scandal (see “Milken Goes Public,” opposite) but also where, on the other, he is preparing for his next financial assault: tapping--and expanding--the $650-billion market in near-defaulted government loans in Mexico, Brazil, Zaire and other Third World nations. “Someone has to solve the problems of Third World debt, and if we don’t to it, the Japanese will,” Milken says.
MILKEN, WHO HAS been compared to legendary financier J. P. Morgan, is a thin man with a large head and deep-set eyes. When he smiles, his toothy grin makes him look much more boyish than his 41 years. So does his suntan and well-fitting hairpiece. He wears a tie but no jacket in the trading-room office, which resembles a casual, democratic newsroom: People talk across desks and there is a feeling of deadline pressure that doesn’t wind down until about 4 in the afternoon, after New York offices close. A mystery to the outside world, Milken is easy-going and accessible to his colleagues.
Even when he arrives at 4:30 in the morning, Milken’s energy is irrepressible. After saying good morning to his assistants--who work in relays, dialing phone numbers and jotting down messages--he begins making his morning telephone calls, or “visits,” as he calls them, to clients, associates and friends, all spoken with a lilting cadence, as Milken issues forth ideas and his views of the world. Almost everyone takes his calls, and everyone listens.
Mike Milken moved his entire 20-man operation over the Fourth of July weekend in 1978 from Broad Street in New York to the Avenue of the Stars in Century City. That July 4 was his 32nd birthday--and his personal declaration of independence from Wall Street. At Milken’s side were his younger brother, Lowell, once a lawyer, now a Drexel vice president; Peter Ackerman, a Ph.D. from Fletcher School of Law and Diplomacy, and Gary Winnick, bond salesman, all of whom, among others, were eventually partnered with Milken in various companies and ventures--and also became multimillionaires.
Milken had been working at Drexel in New York for nine years, since 1969, after he graduated from the University of California at Berkeley and enrolled in the Wharton School of Business in Philadelphia. He commuted to Wall Street from Philadelphia every day by bus, avoiding his competitors and using the time to read prospectuses. He told his boss, “I don’t know if I’m smarter than anyone else, but I can work 25% longer.” As it turned out, he had such a hot hand trading obscure bonds that in one year he doubled the money Drexel gave him to invest and became such a legendary trader that Drexel acceded to his unusual request to move to Los Angeles.
For Milken, it was a return home. He bought a house in Encino only a few miles from where his family lived when he was a child. (The house, although it once belonged to Clark Gable, is not particularly ostentatious.) Milken’s father, Bernard, had been an accountant. At Birmingham High School in nearby Van Nuys, Milken had been elected both head cheerleader and prom chairman, and he also began dating Lori Anne Hackel, whom he later married. Milken then went on to Berkeley, where, in the 1960s, he considered himself something of a rebel because he studied business administration rather than conform to the current political-protest movement; he became a Phi Beta Kappa student and then moved back to Los Angeles, where he worked one summer as an accountant at Touche Ross and Co., commuting to Berkeley for exams.
Even when Milken accumulated massive wealth, he made few adjustments in his new California life. “I have one house, one wife, one cat and one car,” he says of his life in Encino. On a recent summer weekend, Lori Milken served bagels and rolls at poolside while Milken, wearing shorts, a polo shirt and Reeboks, talked easily and amiably; later he went bicycling with his three children, two boys and a girl.
At Drexel, life is not quite so carefree. When Milken first moved to his Century City office he immediately sat at his desk and swiveled back and forth, as if testing the chair. Then, suddenly, he jumped up; one of the traders in the corner of the desk was partially out of his line of sight. He called his office manager over--the trading room had to be redesigned by the next morning; he had to see everyone who worked for him, all the time, as if he were in a cockpit. It was part of his need to be in control. “I’ve never had a private office in my life,” he says. “I have to know what’s going on.”
Milken also insists that his staff work the same long hours as he does--even if it means a 17-hour day. In 1983 Milken moved his office from Century City into the Gump’s Building in Beverly Hills, which he now partly owns, and had a bridge built connecting it to Drexel’s corporate finance headquarters in the next building; his office became his private world. On paper, his staff works for Drexel, but in fact, as they all know, whether in Beverly Hills, Chicago, New York, London or Tokyo, they are Milken’s people. Milken has his own lawyer, strategists and public relations staff. He also has three shifts of assistants, the first arriving at 3 a.m. to prepare his work and line up his calls. Milken never writes down orders to buy or sell bonds himself; instead he turns around and screams the order to “anyone I’m looking at.” His hectic office averaged, according to a sworn deposition he gave in a lawsuit in 1986, “a quarter million transactions a month,” with money being moved from one coded account to another without the name of the buyer or seller being identified.
WHAT LED TO Milken’s power was an idea and the ability to implement it. The insight originally came to him in the mid-1970s, when he was trading bonds of once-great industrial giants that had fallen on hard times. Since the established bond-rating services, Standard & Poor’s and Moody’s, had taken away these companies’ seal of approval--the A rating--institutional investors, such as insurers and pension funds, shunned them. They were “fallen angels” selling at a deep discount, as low as 10 cents on the dollar. Yet among them Milken found a few that, despite their lack of an investment-grade rating, were fully backed by assets that, if liquidated, could repay the bonds 100 cents on the dollar. This meant he could make a fortune buying them at a discount. But he also saw a larger picture: If the rating services were using the wrong criterion--past performance--in assigning their ratings, the $800-billion capital-rated market, in which institutional buyers of bonds depended on the letter-grade of a bond, was limiting itself to too few companies. Until then, the corporate bond market was effectively closed to all companies that did not get an investment grade rating from Standard & Poor’s and Moody’s, which meant that, as Milken explains, “only 600 to 700 companies out of 25,000” had access to this pool.
What Milken saw was a way for new and medium-size corporations, which did not have the necessary track record to get an investment-grade rating, to borrow the money. He would sell unrated bonds for them. These would be issued, right from the start, as “junk bonds.”
But who would buy these unrated bonds? Milken felt that the problem of finding buyers was rooted in the financial Establishment’s view of bonds, which, he says, regarded them as virtually risk-free investments for life insurers, pension funds, bank trust departments, college endowment funds, and so on. The investment-grade rating supposedly assured there would be no risk. Any bond lacking this seal of approval was an unnecessary gamble.
Milken knew that the financial institutions’ money managers, who bought almost all corporate bonds, would be resistant to change. So long as the bonds they bought carried the proper rating, their careers were not in jeopardy, even if the bonds went bust (as, for example, the Washington Public Power Supply bonds did). To find customers, Milken had to break the lock the rating services held on the institutional money managers. Deciding that the Eastern Seaboard-based money managers were unlikely to change, Milken turned West, to the Sun Belt, focusing his energy on the younger, more aggressive fund managers in non-traditional institutions. He looked, as he later explained, for managers “who were judged by performance rather than their conformance.”
Los Angeles was the logical place to begin his crusade. Like a traveling salesman, Milken pitched from office to office, trying to convince the money managers that his junk bonds could give them the extra performance that they needed. According to one fund manager, Milken compared the two rating services to movie reviewers who shared the same bias. He suggested that if theater owners read “incorrect reviews” of “Star Wars” from two such reviewers, they might never have booked the film--and they would have missed a bonanza. What fund managers had to “learn to do,” Milken argued, was to “ignore the reviewers.” The alternative he presented was a diversified portfolio of junk bonds, and he argued that the premiums these bonds paid would more than compensate buyers for any losses that might occur through defaults. The present ratings services simply “had the wrong computer program.” By concentrating on past performance and placing weight on such factors as how many years companies had paid dividends without interruption, the ratings services neglected the future--which determined whether the bond holder would be paid. Milken’s strategy was successful, and by 1980 he had sufficient converts to create a stable market; enough customers, Milken says, “with billion-dollar checks in their pockets.”
Then Milken did something that no other bond salesman had done. He hosted a series of his own annual institutional-investment jamborees for money managers in Beverly Hills, formerly called “The High-Yield Bond Conference”--or, by the participants, “The Predators Ball.” He hired fleets of stretch limos, took over Chasen’s for dinner (carefully arranging seating as a sign of importance) and hired entertainers such as Frank Sinatra, Diana Ross and Kenny Rogers to serenade the money managers. For his more exclusive clients, there were also stag parties in a bungalow of the Beverly Hills Hotel, attended by starlets arranged through a model agency partly owned by one of his business associates.
We all recognize we don’t like change. We don’t like it when our children stop listening to “Mary Poppins” and all of a sudden have rock videos blasting in the house. We don’t like it when they change their hairdo or dress. People who run corporations don’t like change either. One way to insulate yourself is to deny change is occurring. You lash out at people, and who’s easiest to lash out at? Wall Street.
--Mike Milken at the April 1, 1987,
Drexel Burnham Lambert Institutional
Investment Conference
THE CHANGE MILKEN had brought about was that the bond market was no longer peremptorily closed to the 95% of America’s corpora tions that could not get an investment-grade rating. He could raise money for virtually any company that could demonstrate a cash flow sufficient to repay the bondholders. And the results were good: Companies financed with Milken’s junk bonds, rather than defaulting, boomed. Either through a visionary selection of the right bond issuers, or by fast footwork in saving those that got into trouble, Milken provided the fund managers with returns that made them look very good. According to Fortune magazine, not one of his bonds defaulted in 1986.
The relatively small stream of money Milken had generated from the junk-bond market in 1978--less than $1 billion--turned into a torrential river of funds by 1986--$125 billion. More than 900 companies had become issuers of junk bonds--more than the number of companies issuing investment-grade bonds. Industries such as cable television, health care and regional airlines were helped by proceeds from sales of the bonds; junk bonds also opened up new areas of competition. MCI Communications, for example, used its junk-bond financing to build microwave relay stations which successfully undermined the AT&T; monopoly.
Traditional corporate management still resisted. If money raised from the sale of junk bonds had been used only for the modernization of medium-size companies, traditional corporate America might have gone along. But as the money poured in, Milken and his associates at Drexel began using it to finance corporate takeovers-- first, leveraged buyouts, then hostile raids. In order to make these takeover bonds less risky, Milken arranged the transaction so that the bonds were issued only when the raider acquired control of the company. If the raider didn’t acquire control--as was the case with Saul Steinberg’s bid for Disney--the person committing the money never had to put up any cash. In either case, Milken and the lender-in-waiting each got a handsome “commitment fee” from the raider. Institutions, seeing a profit with a minimum apparent risk, rushed in to provide this takeover financing. Through Milken’s new financial network, individuals and groups such as T. Boone Pickens, Carl Icahn and Ronald Perelman were aided in their continued bids for control of America’s largest corporations. Suddenly, as Forbes warned on its cover, no one was safe anymore.
BY THE MID-’80s, Milken had elevated Drexel from a minor investment bank to the position of pre-eminent underwriter of junk- bond corporate debt and one of America’s most profitable companies, with a pre-tax profit in 1986 (before bonuses) rumored to be in excess of $1.5 billion. Corporations became clients of Drexel when they needed the money Milken could provide--sometimes, according to insiders, out of fear that if they didn’t, Milken would help finance a potential raider.
Also by 1985, Milken had become one of the 75 richest men in America, with a fortune estimated between $500 million and $1 billion. He is said to be, after the Banque Lambert Bruxelles and the Drexel Burnham Pension Plan, one of the largest single owners of Drexel. He also has a Milken Family Foundation which, in 1984 alone, bought more than $100 million in securities. For his bonuses in 1986, he took a third of the more than $300 million Drexel paid his office. Much of the rest went to his brother Lowell and other top staffers--who then invested it, with Milken, in private ventures, “highly aggressive investments,” as one of his aides explains.
Because of the extreme secrecy he employs in weaving together these different strands of his empire, its full scope is kept obscure. But from the few threads that have surfaced in legal suits against him, it is clear that this is not a conventional Wall Street operation. For one thing, Milken, under different hats, takes different sides of the same deal. He acts not only as an adviser but also as a buyer and seller of bonds, a market maker, a banker and an active partner. His clients--with the notable exception of Green Tree Acceptance, which has sued Drexel, claiming that it was made vulnerable to a hostile takeover by another Drexel client--do not express concern about Milken’s protean roles. Many of them see Milken as someone who has the ability to get what they want: money for expansion. As Ralph Ingersoll II, the chairman of Ingersoll Publications Co., explains, “Milken has an extraordinary gift for figuring out credit risk--we all benefited from it.” Outsiders and competi tors saw Milken’s unconventional deals in very different terms: He represented both his client, himself and his other associates in a way that would ineluctably raise questions about self-dealing. As a member of the board of Western Union stated after doing business with Drexel, “I don’t know if Milken knows the meaning of conflict of interest.” In any case, in a rising market, where everyone made money, Milken seemed able to satisfy all participants. While it all may have been legal, and even beneficial to the parties concerned, it made even some of his associates wary. As one arbitrager familiar with him since 1980 explained, “Mike was pushing things to the limit.”
Milken could point out that not only had none of his bonds defaulted in 1986, but they also showed less up-and-down volatility than rated bonds.
But critics--and competitors--have suggested that Milken had merely created the illusion of a deep and well-functioning market by using his own private network of companies and allies to buy and sell bonds at strategic moments. Even one of his own aides talked of the role of “optics”--optical illusions--to support the market. Such concerns, Milken claims, whether or not they had any basis, led the New York State Insurance Department to restrict the percentage of a portfolio that an insurer could invest in junk bonds.
Milken felt the Establishment was using restrictions in order to protect itself. He uses a sports analogy to explain the politics of the ruling: “Just imagine there was a baseball team, like the New York Yankees, that won all the time,” he says. “It even came to believe it had a divine right to win. Then a new team came along whose pitchers knew how to throw curve balls and sliders that its hitters couldn’t hit. It began to lose. So its manager decided, rather than teach the team how to hit these pitches, to go to the commission--and have them banned.”
Milken knows that his ideas were considered, as he puts it, “subversive,” but he doesn’t think of himself as a revolutionary. “All the revolutionaries I know are dead,” he says, deadpan, but he also knows that to some corporate managers what he was doing was tantamount to revolutionary activity. And despite the consequences he feels he might be made to suffer from this activity, Milken is moving ahead with the next stage of his game plan: “going international.” His new target dwarfs the junk-bond market and rivals the investment-grade $800-billion rated-bond market: “sovereign debt,” the bonds and loans that governments issue on the world market to finance wars and trade deficits.
Milken frames his strategy in terms of what he sees as a battle between the United States and Japan to control world finance, with Japan positioned to replace the United States as the dominant financial power. Milken switches to a medical analogy--with banking arrangements as “arteries” and loaned money as the “blood.” As American banks withdraw their money from the Third World, he suggests, “it is like taking blood out of arteries, and if you stop pumping the blood, these financial channels are going to collapse.” Then, “the Japanese build their own arteries through the Third World--and, through them, control the terms of trade.”
Looking at this “junk-country” debt as he had the junk-bond market, he immediately recognized the similarities. “In both cases, neither the buyers nor the sellers were comfortable with the existing setup.” The buyers were international banks, who carried these loans on their books at “100 cents on the dollar,” and the sellers were countries like Mexico, Zaire and Brazil--which could repay the loans only by borrowing more money from the buyers. And, as in the case of the pre-1977 junk bonds, the loans’ value was not easy to fix: “No one knows what a Zambian bond is really worth.” Nor did these loans have much liquidity. Milken recognized that other banks were attempting to grapple with this problem, just as others had traded junk bonds before him; but he believed that they were limited “by their traditional view of sovereign debt.” What was required was “rethinking the whole issue.”
Milken aimed to create a liquid market in these government loans--even those in trouble. He realized that this required, as in any other market, matching up buyers (which were institutions) and sellers (which were governments). This would depend on establishing some realistic price for these loans, “whether it is 10 cents or 50 cents on the dollar,” he says. Once the loans had such a value, banks that didn’t want to hold them could sell them to others who did. This was no minor undertaking; major banks had tried for years to cope with Third World debt, and many are this summer writing off tens of billions of dollars in loans.
DESPITE THE OBVIOUS complexity of Third World debt, Milken has already hired about 40 country special ists--including geopoliticians, economists and currency traders. His idea is to have them study the situations of these debtor countries as if they were evaluating the balance sheet of troubled corporations. Once this is done he foresees advising countries, as he advised corporations, on ways to “restructure their economies.”
His prime candidate is Mexico, with $85 billion outstanding in foreign debt. His plan is to arrange for other parties, primarily Japanese and Taiwanese corporations, to buy up a large portion of this Mexican debt--at discounts of perhaps 50 cents on the dollar--and then sell the loans back to the Mexican government in exchange for land or local businesses. The idea, says Milken, is to build industry in Mexico, which could then re-export the products to the United States in a kind of triangular trade arrangement. The Japanese already invest in Mexico and the United States, but Milken envisions an enormous expansion financed by junk-country loans.
Milken has described Japan as “a sealed house in which each month the world shoved another $10 billion under its doors.” Japanese corporations have to find ways of reinvesting this money outside their house. Taiwan has a similar problem. The solution, he submits, is Mexico, “the last country the U.S. is going to put barriers up against.”
Like many of Milken’s ideas, this scheme is both convoluted and original. With it, as with his junk bonds, Milken ignores conventional boundaries between banking and entrepreneurial finance. He is proceeding, moreover, at a time when his legal future is problematic. His success in a field where the international banks have failed hardly seems likely--but then, junk bonds hardly seemed a likely strategy either.
