Legitimizing Junk Bonds Will Be Milken’s Legacy

In September 1989, the Los Angeles Music Center Opera staged the Puccini tragedy “Tosca,” in which an artist whose only crime is loyalty is destroyed by a brutal, envious prosecutor.

To Michael Milken, seated in the audience, there seemed a poignant analogy to his own career, he later remarked.

Milken, after all, considered himself an artist of finance, the man who used once-spurned junk bonds to spark a corporate restructuring boom in the 1980s that revitalized American business, unlocking vast efficiencies and profits that others lacked the vision to imagine.

Moreover, Milken was the target of a relentless federal prosecution that, according to his many ardent defenders, was driven largely by envy of his riches and power, plus a desire for a prominent scapegoat for the government’s own economic policy failures.

Nonsense, Milken’s opponents replied. His crimes undermined investor confidence in the markets. His machinations spurred wasteful takeover wars that destroyed jobs and companies. And with his 1987 earnings of $550 million, he embodied the Decade of Greed.

Literally speaking, the jury is not out on Michael Milken: It never got the case.

Seven months after “Tosca” and a year after being indicted on 98 federal felony charges, the former junk-bond chief of Drexel Burnham Lambert pleaded guilty to six felony counts including securities fraud and conspiracy. Among other things, Milken pleaded guilty to conspiring with arbitrager Ivan F. Boesky and another colleague to violate tax and securities laws through illegal stock trades and secret records.

Milken served 22 months in the federal prison camp at Pleasanton and paid $1.1 billion in fines and penalties.

Yet debate over Milken’s achievement rages still. One indisputable part of his legacy is the legitimization of junk bonds. What was once an investment backwater is now a $1-trillion market.

The son of an Encino accountant, Milken whizzed through Berkeley and the University of Pennsylvania’s Wharton School, then landed a job at Drexel, a Wall Street investment-banking firm with a distinguished pedigree but a fading franchise.

Milken gravitated to the nether world of junk bonds, considered too risky for conservative investors because of doubts about the issuing companies’ ability to pay interest and principal. With the risk came high yields.

Because junk bonds were low-rated or even unrated by rating agencies, investors needed the same kind of research into the issuing companies that equity analysts performed on stocks. With his near-perfect memory and calculative skills, Milken became a junk-bond encyclopedia, succeeding wildly as a salesman and trader.

His department became so important a profit center that by 1978 Milken could demand that Drexel let him move the whole operation West to be near his and his wife’s hometown and relatives.

It was there, first in Century City and finally at the corner of Wilshire Boulevard and Rodeo Drive in Beverly Hills, that Milken reached the zenith of his power, directing his crew of millionaire employees from the crux of a huge, X-shaped trading desk.

In the mid-1980s, a takeover wave unlike any the U.S. had seen before began to take shape. Established firms such as Beatrice Cos., National Can, Hilton Hotels, TWA and Unocal found themselves under attack, often by smaller upstarts armed with junk bonds.

Others may have realized that junk bonds could play a role in financing hostile takeovers, but it was Milken who created the apparatus--the network of buyers and issuers--that made it happen.

He worked 14-hour days, a phone at each ear, developing relationships not only with the institutional investors who bought the bonds but also with the maverick entrepreneurs who issued them, including corporate raiders such as T. Boone Pickens, Carl Icahn, Ronald Perelman and James Goldsmith.

Many of their acquisitions were leveraged buyouts, or LBOs--outright purchases in which the shareholders were bought out with a combination of junk bonds and cash. The surviving company typically would restructure, ousting management and selling or closing operations that were unprofitable or didn’t mesh with the new, streamlined business plan.

Such “rationalization” cost thousands of jobs but arguably created thousands of others by freeing companies of inefficient operations and managerial bureaucracy, enabling them to grow profitably for years to come.

Taken to excess, the LBO could result in a company so weakened by bond-payment obligations that it would eventually collapse. Under the weight of a slowing economy and such ill-considered deals, the junk-bond market suffered a collapse in 1989.

Academic opinion is split on whether the debt-fueled takeover wave was ultimately healthy for the U.S. economy. There is no doubt, however, that its impact was lasting.

With their attacks on entrenched managers and unproductive assets, these corporate raiders helped usher in an era of greater shareholder activism, more linkage between stock performance and executive pay, and increased attention to wringing maximum efficiencies and profit from company assets.

Milken, barred from the securities industry for life, now divides his time among a variety of business and charitable interests. He has launched a think tank, a computer-training firm, a prostate-cancer research initiative and a variety of educational projects.