Milken, Drexel and Perestroika Jude Wanniski September 22, 1988

Edward J. Epstein is a renowned, albeit iconoclastic, author and journalist who writes of the political and financial worlds. He has spent considerable time studying Drexel Burnham, Michael Milken and junk bonds in the context of the Boesky scandals. He thinks the government's targeting of Michael Milken and Drexel Burnham is largely political, that Milken "is no crook." I tend to agree. The courts might indeed find against Milken in the SEC civil suit, the way any of us could be nailed on something or other if the government put us under a microscope and combed through our careers. I'm also keeping an open mind that Rudolph Giuliani might persuade me that Milken danced around the frontiers of the law. Epstein's point, though, is that Milken's financial revolution so upset the Establishment -- the captains of industry and their bankers -- that in an organic sense it rose up against him and upstart Drexel, using its agents in the government and the press to put a halt to their activities.

My tendency is also to believe that Milken, junk bonds, and the M&A phenomenon are all byproducts of the Reagan Revolution. I've long believed that rising real rates of taxation in the 1970s led to the conglomeration craze, odd-couple enterprises merging in order to economize on taxes. The sharply lower personal and corporate rates of the Reagan years vastly increased the potential earning power of corporate assets, but the management teams at many of them were unsuitable to the challenge. They had climbed to the top with talents needed in the conglomeration era, not the entrepreneurial era of the Reagan years. Still, they were entrenched, as unwilling to yield to the necessary perestroika as is the Soviet bureaucracy to Gorbachev's. Milken's junk bonds and the network he created to quickly provide them a mature, liquid market were a stroke of genius, precisely the vehicle needed at this moment in U.S. history. They served the needs of the entrepreneur and also the needs of entrepreneurial financiers who recognized the need for an unwinding of the conglomerates in this new milieu. Drexels' senior employes got discounts not because of greed, but because it was important to Milken to have them act as principals in his network, making markets in the bonds when none before had existed. Drexel has ended the practice, but it's no longer needed, the market now taking wing on its own.

Ivan Boesky was a crook, driven by a venal greed, and Giuliani had him cold, with satchels of greenbacks to boot. But it has taken Giuliani and the SEC this long to bring charges against Milken because what they have doesn't quite make sense. They are trying to prove a vulture, but the animal seems more a sharp-clawed American eagle. The charge that Drexel and Milken benefited by having Boesky drive up prices a few points here and there, adding to their commissions, is ludicrous. There is no sense of proportion, as if alleging that Al Capone occasionally took time out to stick up a candy store. Milken was clearly being driven by historic forces, in the manner of the Morgans, Rockefellers and Gianinnis of an earlier era. At the time of his dealings with Boesky, Boesky's reputation was golden, a pillar of the community. The government has to prove that Milken knew he was dealing with a crook, that Milken, like Boesky, was manipulating the market, not simply creating one. Boesky says he was, but crooks generally tend to think that everyone is a crook. It eases their consciences. Neither the government nor Milken and Drexel nor Drexel's clients have been acting as if they believe the dots can be connected in a way that will persuade a jury.

Milken's great insight was one that should give great comfort to those who worry that the junk bond market was created through manipulation — and thus could collapse if the government succeeds in bringing him and Drexel down. There's a parallel with A.P. Giannini's founding of the Bank of America in 1904. Giannini's insight was that San Francisco's unwashed illiterate Italian immigrants were good credit risks, contrary to conventional wisdom in the banks of the era. Giannini parlayed this insight into the biggest commercial bank in the nation by 1945, fighting the Eastern Establishment all the way. Many of the banking laws passed in the 1930s to restrict interstate banking and other innovations were stop-Giannini laws, pushed by his competitors' fears that he would stretch the B of A from coast to coast. It is in this sense that Epstein sees the case being made against Milken as being largely political. (I recommend Gary Hector's new book, Breaking the Bank: The Decline of Bank of America.)

Milken's insight was that the unwashed entrepreneurial class in the 1980s was a good credit risk. Growing businesses with dynamic founders and solid ideas, spurned by banks that would rather make sure bets (on Third World governments), could raise capital through Milken's high-yielders. As with Giannini, there was a chicken and egg problem. Milken's network of cross-ownerships, which looks suspicious because it had not been seen before, solved the chicken/egg problem. In an entrepreneurial era, junk bonds will work. The market will not collapse unless Washington is persuaded to end the entrepreneurial era, putting tax rates back up to smother incentives. Of the $104.8 billion Drexel has raised to date with high-yield instruments, a mere $6.9 billion has been used to finance unsolicited, hostile takeovers. More than half, $56.6 billion, has gone toward new growth. The remainder financed friendly acquisitions. This helps explain why Drexel's customers remain so solidly supportive, and why so many competing houses that for so long decried the junk market are taking the plunge. In a Bush presidency, with chances of a capital gains tax cut to 15% or so, the "junk" market would be hotter still.

It helps to keep these events in focus, and not jump to conclusions or rush to judgment about Milken and Drexel Burnham Lambert. I've never met Milken and have no business connection with Drexel. I have no doubt that Milken is as hard-charging, impatient, and at times vindictive as I've read he is. The pattern of his career, though, does not suggest corruption. Boesky's corruption seems driven by his own realization that he was not the genius he was thought to be. Milken's problems arose through his obsession with creation, with the usual impatience for rules laid down for mere mortals. He has lived relatively simply, by all accounts a devoted husband and father in the few hours a day he has not been working. If I put myself in his shoes, realizing what he has accomplished, I can square his behavior with worthy motivations. I've heard from people who have known him that he's a brilliant but mean SOB, who stomps opponents. Others tell me that while he's relished seeing zeroes tacked on to his net worth, he's basically honest. His greed has not been venal, but a way of keeping score. Such men do not count dollars they've acquired unscrupulously, nor need they.|

Whether or not he will extricate himself from his current difficulties, he's already earned a niche in the pantheon of world financial wizards. At a critical turn in the American economy, still unfolding, he created invaluable tools for the restructuring, the perestroika. As with other such wizards of history, it's no wonder he's met resistance.