COMMENTARY : THE MILKEN SENTENCING : Easy Credit, Empty Deals From a Misbegotten Decade

Michael Milken’s 10-year prison sentence reflects, among other things, public anger at the deal makers of the 1980s who enriched themselves and left others, including the taxpayers, holding the bag.

But anger without understanding avails us nothing. The question we should ask is: What have we learned from Milken?

We have learned again that financial genius is before the fall. The Milken sentenced Wednesday is the same man who was hailed as the new J. P. Morgan, come to remake American business. Like scores of speculative geniuses before him, Milken turned out to be a false prophet. Maybe the next time, the public will be more skeptical and regulators will act more quickly to protect the financial system.

But maybe not. Another lesson we have learned is that credit expansions take on a momentum that is hard to stop, simply because so many people benefit from easy credit. Milken was not the only juggler in the circus of the ‘80s. In some ways, Pogo’s famous line applies: “We have met the enemy and he is us.”

We have learned that using borrowed money to build a factory is very different from using it for a leveraged buyout. Japan borrowed for factories, the United States for deal making--which is why Japanese firms today are buying U.S. companies rather than the other way around.

Finally, we have learned that brains and ability without integrity can damage our institutions. America is financially weaker today because of the distortions of the ‘80s. And Milken has a lot to answer for, not only for illegal acts but for maneuvers that were legal but antisocial.

“It was a misbegotten period,” says James Grant, editor of Interest Rate Observer, a newsletter that spoke out early on the follies of the debt craze. “It was a cosmic lapse in the art of lending, going far beyond a single class of loans such as junk bonds.”

Milken’s influence stemmed from the market he built for high-interest, or junk, bonds. Still, the junk bond market at its peak totaled $200 billion, a drop in the bucket compared to the $10-trillion total debt in the U.S. economy--from consumer credit to government bonds and all other borrowing. That total debt roughly doubled in the 1980s.

And Milken’s influence was magnified by financial go-betweens, called investment bankers, because he made millions for them. In one of the first big takeovers, Milken’s firm, Drexel Burnham Lambert, financed T. Boone Pickens Jr.’s raid on Gulf Oil. When Gulf was eventually bought by Chevron, Merrill Lynch, Salomon Bros. and Morgan Stanley shared almost $70 million in fees.

Later the business got even better. In the RJR Nabisco deal of 1988, fees paid to lawyers, commercial bankers, investment bankers and others may have totaled as much as $1 billion.

“My surprise,” says Martin Mayer, author of books on financial markets, “was that leading lawyers, investment bankers and accounting firms didn’t speak up about these risky deals out of responsibility to their profession and to the country.” They didn’t speak up because they were making too much money.

But they spoke up when Paul A. Volcker, chairman of the Federal Reserve, tried to stop the money. Seeing growing takeovers as “speculative froth,” Volcker proposed limiting credit by raising margin requirements on stock purchases in the fall of 1985. He was shouted down by Wall Street firms, protesting to the Reagan Administration. The Fed withdrew its proposed margin increase, and the dance went on until the Crash of 1987.

Milken still claims, and others proclaim for him, that he helped revitalize U.S. business competitiveness. But that’s not true. If American business became more competitive in the 1980s, it did so under pressure of global competition, not junk financing.

What Milken and the decade specialized in was persuading the public that two plus two equaled not four but five or even six. Takeover artists could say a company was worth more than the market price, and that management should boost the stock or a takeover would. Then, using Milken’s junk bond financing, they would bid up the stock price--rewarding market speculators--and buy the company, paying off present shareholders.

After that the pattern of normal corporate finance, in which investments are made in plants and machines to produce a stream of income from which to pay wages and dividends for years into the future, would be abandoned.

Instead, future cash flow would be brought forward to the present, by forgoing new investments and harvesting depreciation on the old. A junk-financed Pacific Lumber hurrying the harvest of old-growth redwoods to maximize cash flow is an example of the practice. That speeded-up cash flow would then be paid in interest to bondholders.

It was a system that rewarded the present but aborted the future. And yet that is how a large stretch of America behaved in the 1980s, when U.S. business converted $500 billion of equity into debt and legions of experts prattled about “maximizing shareholder value.”

Japan, too, had a riot of borrowing and speculation in the ‘80s. Yet somehow its corporations used enough of the money for plant and equipment that now they outdistance U.S. business in capital investment and research spending every year.

Milken understood this. An intense, highly intelligent man, Milken understood the competitive decline of the United States. He would reflect in private moments that his sons went to a Japanese youngster’s house to play Nintendo because Japanese Nintendo was more difficult than the version marketed to Americans.

Dumbed-down Nintendo spoke to Milken of a society in decline. Yet he used his undoubted brilliance not to make a positive difference for America, but to pile up billions of dollars in secret partnerships and deals, over and above his well-publicized compensation from Drexel.

Milken’s offense is not that he got rich but that, like so much of Wall Street in the 1980s, he enriched himself at the expense of the society that allowed him the very freedom to do so.

In a letter to Judge Kimba M. Wood a week ago, Milken said he was “truly sorry” and asked to be allowed to make recompense through community service. He’ll get his wish. To her harsh 10-year sentence--which seems designed to force Milken’s cooperation with further government investigations--Wood added three years’ of probation during which Milken must do community service. He should. He owes America a lot--but then so do we all.