When Peter V. Uebberoth, the former baseball commissioner, and as squeaky-clean a businessman as there is, had run out of ideas for structuring the purchase of Eastern Airlines, he had a phone conversation with Michael M. Milken, who told him how to do the deal.
Uebberoth's deal eventually fell through for other reasons. But the incident illustrates the profound influence that Milken--the erstwhile "junk bond king" of Drexel Burnham Lambert--exercises over the financial world, and the reason deal-doers beat a path to his door.
Amid all the clamor to bury Milken, it is time we also praised him.
It is, after all, not true that Milken "lied and cheated" his way to great wealth, as the press reports currently put it. It is possible that he got some of it that way, but that will be for a jury to decide. In fact, none of the charges against him assert that more than a small fraction of his billion-dollar-plus fortune may have been earned illegitimately.
But the prevailing tone in the press is that making a billion dollars is dishonest in itself. And it is odd, to say the least, to hear billionaires like David Rockefeller and Donald Trump solemnly aver that Milken's earnings are excessive. Rockefeller can assume the high moral ground, presumably, because his parents gave him his money, his grandfather's rapacities laundered away by time. Trump earns his by cadging quarters from old-age pensioners in his Atlantic City casinos.
Milken earned his money by effecting a genuine financial revolution. His own wealth, huge as it may seem, is only a fraction of the enormous savings and earnings he produced for the sellers and buyers of his fabled junk bonds.
Milken's revolution is one of several over the past decade or so. One has to go back a century, to enterprise's Homeric age, when John D. Rockefeller, J.P. Morgan and their fellows created modern capitalism, to find a time of similar financial upheaval.
The first of the recent revolutions was technological. Marrying computer power, particularly desktop computer power, with global communication systems allowed financial tides to flow freely around the world. If U.S. interest rates rose, money flowed instantly from Asia. Excess savings in Japan and West Germany, which in another era would have caused a world depression, instead sparked a consumer boom in the United States.
At the same time, the desktop computer made reality out of the academician's theory that at some price any financial instrument is equal to any other.
Not long ago, the financial world was divided into rigid channels. Insurance companies and pension funds made long-term, fixed-rate loans to major corporations by buying investment-grade bonds. Commercial banks made short-term working capital loans at floating rates. Successful companies could also raise long-term money by selling stock.
Access to all these channels was centered in Wall Street, controlled by the "white shoe" banks and investment banks, and managed by the none-too-diligent scions of traditional WASP, Ivy League families. Ease with a wine list and skill on the golf links were as important to success as business acumen.
One example of the old system's rigidity: Not many years ago, high-grade Japanese companies could not sell their bonds in the United States because the traditional U.S. bond buyers did not know their names. The only American financial channel open to them was shorter-term floating rate loans from commercial banks.
Investment bankers at Salomon Brothers and First Boston Corp. developed the concept of "securitized assets." Few investors have the appetite for paper as long-term as real estate mortgages. But to an investor, a mortgage represents just a stream of payments stretching into the future. With a computer, it is easy to chop up the payment stream into three-year packages, five-year packages or even separate interest and principal packages. Chopped up, or "securitized," the long-term mortgage becomes a whole family of financial instruments, with rates and terms to suit a variety of investment appetites. At a stroke, a much broader pool of capital is available for mortgage lending to everyone's benefit.
Milken's revolution is the one most identifiable with a single individual. While still a student at the Wharton School, he noticed that only a few hundred American companies had access to the long-term bond market. The vast majority could borrow only from banks at relatively short terms, and usually at floating rates. Milken demonstrated on paper that the credit experience of the average company justified far better credit access than was actually available.
When he was hired by Drexel, he sold his idea of opening up a new channel of bond financing and negotiated a fixed percentage of any profits Drexel earned. His first bond sales were called "junk bonds," because they carried a higher interest coupon than typical blue-chip bonds. High-yield bonds had always been bonds from blue-chip companies that had gotten into trouble--known as "fallen angels" in the trade, or just "junk."
When the economy took off after the 1981-1982 recession, Milken's new junk bond market boomed; Drexel swept past old-line firms to the top of the underwriting league. Without Milken's junk bonds, some of the companies he financed would not have found credit available, the U.S. economy would have been less liquid, interest rates higher and industry less productive.
Although yet to be tested by a severe recession, junk bonds have so far proved a good financial risk. The average junk bond pays about 4.5% more than a Treasury bond, the benchmark risk-free investment. So far defaults have cost investors only about 2.75% of their investment. The difference is pure profit to the investor.
Junk bonds proved such an ideal tool for corporate raiders that Milken's name is irretrievably associated with the takeover boom of the 1980s. But only about 40% of the $185 billion in currently outstanding junk bonds was actually issued in connection with takeovers--and, of course, many were friendly.
Excess is in the nature of the capitalist system. Perhaps the takeover fad has been carried too far, although that is by no means clear. And perhaps the junk bond market is over extended. And perhaps Milken will be found to have abused his financial power. But his accomplishments have been extraordinary with stupendous benefits to the country; he should be remembered for them, as well as judged for his alleged offenses.