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Wall Street History
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02/11/2000
Michael Milken, Part IV...the Fall
"The plans of the great financier may act as a catalyst to a
speculative mania, but the financier himself does not remain
untouched by events. His ambition becomes limitless, a chasm
opens up between the public appearance of success and universal
adulation, on the one hand, and the private management of
affairs which become increasingly confused and even
fraudulent."
--Edward Chancellor
As the hostile takeover deals heated up in the mid 1980s, several
anti-takeover measures were before Congress. The public was in
an uproar over the number of jobs being lost with each
restructuring once a takeover went through. Of course, looking
back, you can say some of this action was a leading reason for
the current boom that the American economy is in. Corporate
America became lean and mean. The Europeans are finally
learning this lesson the past few years and it is contributing to the
tremendous changes taking place there as well.
But back to Michael Milken and his junk empire. It all began to
crumble on May 12, 1986 when Drexel banker Dennis Levine
was arrested on charges of insider trading in 54 stocks. As
author Robert Sobel notes, "This was for Drexel the equivalent
of what the discovery of the Watergate break-in was for the
Nixon administration."
Levine had been a rising star at Drexel but between 1980 and
''85, the government alleged he had made more than $11 million
on his illicit trades.
Enter SEC chief of enforcement, Gary Lynch and U.S. attorney
Rudy Giulliani. They offered Levine a plea bargain if he would
cooperate with them. Levine accepted and fingered arbitrageur
Ivan Boesky [see previous "Wall Street History" pieces].
Boesky, in return for his plea bargain, then fingered Martin
Siegel, who was also at Drexel. Siegel then admitted to insider
trading while at Kidder Peabody, and he, too, agreed to
cooperate.
Levine, Boesky and Siegel were imprisoned, receiving light
sentences for having cooperated. Siegel fingered other bankers,
including Robert Freeman of Goldman Sachs, who also went to
prison.
By 1987 and early ''88, the atmosphere at Drexel''s headquarters
in New York as well as Michael Milken''s Beverly Hills
operation was tense. Boesky had told Giulliani of his dealings
with Milken. Giulliani then used the Racketeer Influenced and
Corrupt Act, RICO, to go after Milken. RICO had been
previously used against organized crime. In September, 1988 the
SEC charged Drexel with 21 violations of securities laws, 2 of
which involved insider trading. In November similar charges
were "initiated" against Milken. Several bankers agreed to
testify with promises of immunity and plea bargains.
Sobel: "Giulliani felt he had the power to destroy Drexel without
a trial." He told CEO Fred Joseph that he needed to agree to a
settlement on his terms. As one Drexel banker characterized the
meeting, "Giulliani put the gun on the table and said to us,
''Either you will pick it up and use it on yourself, or I will.''"
Milken and Drexel were Rudy''s prime targets. And to Congress,
they realized Giulliani was doing what they had intended to do,
only swifter and more effectively.
In the end, Drexel''s 22-member board elected to cooperate with
the government. On December 21, 1988 they agreed not to
contest six charges of malfeasance and pay $650 million in fines
and damages. And Drexel also agreed to put Milken on leave of
absence with no one at the firm being permitted to remain in
contact with him. All of this took place without Milken being
formally charged with any crimes.
The Street cheered. Of course, they had been jealous of Milken
and Drexel''s control of the junk-bond market. But who would
fill the gap? Prices started to decline, more from fears of
liquidity than anything else.
In June, 1989 Drexel''s bankers were unable to roll over $40
million of commercial paper for a client, Integrated Resources.
In the past Milken had rescued clients like this. But not this
time. Integrated defaulted on $1 billion of debt, most of it owned
by Drexel customers. The default jarred Drexel''s clients and
customers alike.
Two months later Congress passed the Financial Institution
Reform, Recovery, and Enforcement Act which required thrift
institutions to mark their junk bonds to market, which is to say,
carry them at market prices rather than face value, meaning that
some would show large losses due to the sell-off. In addition
they would have to dispose of their junk portfolios by June 1994.
As Sobel writes, "This whole act caused a loss of confidence in
thrifts, which hemorrhaged deposits, even though most were
covered by federal insurance. In 1988 there had been 223
failures, in 1989 there were 328 but none as a result of their junk
bond portfolios." In 1990, out of 217, it was estimated that 4
were junk related.
[I just have to add the thought that when you look back on how
bear stock markets begin, often "bad legislation" has played a
prominent role.]
The junk network began to crumble. Plus the UAL buyout that
fell through in October (with the Dow Jones falling 6% in one
day) played a key role. Junk failures, which had averaged about
2% in the 1977-88 period, hit 8.7% in 1990.
Drexel was now stuck with a junk portfolio of more than $1
billion that could not be marketed. In early February, 1990, the
crisis came to a head when their Belgian parent refused to extend
its credit line for commercial paper. Joseph hoped for a rescue of
the type afforded Chrysler and New York City (and, as it was to
turn out in later years, Long-Term Capital.though many would
say this isn''t apples to apples). Federal Reserve Chairman Alan
Greenspan offered no help, nor did the SEC.
Fred Joseph said at the time: "There are constituencies out there
that have reason to dislike what Drexel has been able to achieve.
We have found ways to finance medium-sized growing
companies. That had taken a business away from the banks
(and) there were clearly companies that had been attacked in the
takeover game that felt very bitter about us. We were tough on
the way up and we never made friends. We stole business from
other firms. We made the banks look silly. This was pay back
time. The Establishment finally got us."
Late on February 12th, Joseph was told by the Fed to file for
bankruptcy or accept forced liquidation. The board voted for
bankruptcy. There was no panic but much joy as everyone was
more than happy to hire Drexel bankers. But after all of this, the
Wall Street Journal wrote: "Now someone from the Justice
Department needs to explain what it was that Milken allegedly
did to justify the punishment being inflicted on the capital
markets."
Giulliani knew he better get a conviction or he''d have to answer
for the destruction of Drexel. But Rudy resigned on January 18,
1989 and Benito Romano finally brought a 98-count indictment
against Milken, including 54 charges for mail fraud and 33 for
securities fraud. If found guilty he could be stripped of all he
had and incarcerated for up to 520 years.
Originally Milken''s attorney was Edward Bennett Williams but
Williams was dying of cancer. He had wanted Milken to plead
not guilty. Then Arthur Liman took over and, on his advice,
Milken pleaded guilty to 6 felony counts, none including insider
trading. Since the charges were light, Liman thought Milken
might get off without serving time. That was not to be as Milken
was sentenced to 10 years, plus 1,800 hours of community
service a year for 3 years, and was fined $200 million (on top of
$400 million already paid into a restitution fund). Later there
would be an additional $500 million. 6 years of the 10 had been
for assisting the dirtball, Boesky.
Judge Kimba Wood said on sentencing, 11/21/90:
"When a man of your power repeatedly conspires to violate, and
violates, securities and tax laws in order to achieve more power
and wealth for himself and his wealthy clients, and commits
financial crimes that are particularly hard to detect, a significant
prison term is required to deter others."
Attorney Liman said:
"I am convinced that society needs a certain number of
demons.The case took on the characteristics of a heresy
trial.[Milken had] become a symbol, the symbol of an era, and
it was beyond any kind of control."
Commenting on the whole matter, author Charles Morris writes:
"Milken seems to have been a particularly unattractive
personality - fanatically driven, greedy, arrogant, obsessive,
unfeeling to his subordinates, brutal in negotiations. He is also a
criminal, because he pleaded guilty to specific felonies. But the
actual charges were rather minor and the government never
succeeded in showing that Milken engaged in the kind of insider-
trading abuses that were Boesky''s specialty.The ten-year
sentence handed down by Wood was shockingly severe - a case
of an inexperienced judge playing to the headline writers calling
for blood. Perhaps 12 to 18 months of the sentence could be
attributed to the crimes Milken had pleaded to. The remainder
was the price exacted for being a ''symbol of greed.''"
Author Edward Chancellor comments:
"While it is true that Milken was indicted for relatively minor
offenses (through plea-bargaining) and that, contrary to popular
perception, the great bulk of his fortune was derived legitimately
from his uncommonly generous remuneration package, Milken
was not the innocent scapegoat portrayed by his legal team and
PR advisers. His total control of the junk bond market turned
him and his fellow Drexel traders into bullies and braggarts.
Corners were cut in the pursuit of profit. The lust for money and
power created a collective adrenaline rush that fed upon itself,
until Milken and Drexel became insatiable. Milken
overreached.and brought about his own downfall."
From author John Steele Gordon:
"Milken''s biggest crime, certainly, was hubris. He was
convinced that he was capable of carrying off any deal that he
put his hand to, and he underestimated his enemies. Milken
came to ruin as a financier because he lacked J.P. Morgan''s
sense of limits and of the strength of the forces arrayed against
him. In this way, like hundreds of other Wall Streeters in the
1980s who were making money hand over fist and thought it
would go on forever, he conceived of himself as a Master of the
Universe."
Author Charles Geisst:
"Milken''s contributions to Wall Street remain hotly debated. He
is viewed as a financier of predators, a raiser of capital for weak
companies, and the ultimate inside trader. But there is no
denying that many of the once weak companies that he helped
finance became highly successful in the long run. [Duracell,
Viacom, MCI.to name a few] At the time of his indictment,
the New York Times summed up by saying:
''Michael Milken is a convicted felon. But he is also a financial
genius who transformed high risk bonds - junk bonds - into a
lifeline of credit for hundreds of emerging companies.The
Milken case presents issues far more important than one person''s
slide from the financial pinnacle. There is no condoning Mr.
Milken''s criminality. But if overzealous Government regulators
overreact by indiscriminately dismantling his junk bond legacy,
they will wind up crushing the most dynamic part of the
economy.''"
As for my opinion? One can not forget that between 1980 and
''86, firms employing junk bonds accounted for 80% of all job
creation at public companies (contrary to what may have been
believed). But clearly, having pled guilty to felony charges, he
got what he deserved. And in my value system, his personality
seems so awful that that alone should have warranted time.
Next week, a promised change of pace.
Source: "Wall Street: A History," Charles Geisst
"When Giants Stumble," Robert Sobel
"The Great Game," John Steele Gordon
"Devil Take the Hindmost," Edward Chancellor
"Money, Greed, and Risk," Charles Morris
Brian Trumbore
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