All Commentary
Friday, March 1, 1996

Payback: The Conspiracy to Destroy Michael Milken and His Financial Revolution

Milken's "Crimes" Were Routine Business Practices

Daniel Fischel is eminently qualified to write a book on the attack on Michael Milken and the changes he wrought in the financial world in the 1980s. Fischel is a professor of law at the University of Chicago and also an expert in finance and the securities markets. He writes fearlessly, taking politicians, journalists, judges, and prosecutors to task for their ignorance but mostly venality in the entire affair. And in the course of it all, the reader learns a great deal about the world of finance, particularly the benefits of corporate restructurings financed by high-yield bonds. Any book that accomplishes so much good deserves hearty praise indeed.

The root of a vast amount of economic good and his own success (and later downfall) was Michael Milken’s insight that there was a great untapped reservoir of capital available to entrepreneurs in “junk” (more appropriately called “high-yield”) bonds. These are bonds with a higher risk of nonrepayment than investment-grade bonds and a correspondingly higher interest rate. Wall Street traditionally looked down its nose at such securities; the bond markets were for the blue chips. Those who wanted to borrow large quantities of capital for risky ventures had a very hard time doing so.

Michael Milken changed that. Working at an insignificant New York investment bank, Drexel Burnham Lambert, Milken convinced management to allow him to give his theory a try. Beginning with its first high-yield bond deal in 1977, Drexel swiftly rose to prominence in the industry.

In creating this success at Drexel, Milken also made many enemies. In selling billions worth of junk bonds, Milken angered the Wall Street patricians. Wall Street etiquette was that on big underwritings, the lead underwriter would form a syndicate to spread the risk and share the fees. Drexel rarely ever did this. Milken also made enemies of the old-line Fortune 500 executives who felt threatened by the emergence of competitors for control over their corporations.

One of the book’s virtues is Fischel’s ability to set the record straight about financial dealings, such as leveraged buyouts, which have been so demonized in the press that most of the public believes them to be no different from pillage. But all the “raiders” were doing was competing for control by purchasing stock. In the ’70s and ’80s, there were many overextended and ineptly run corporations in the country. That made it possible for the takeover specialists to profit by taking control, replacing complacent management teams and selling off parts of the corporation that didn’t fit in. In the free market, you don’t make money by destroying things. When the “raiders” made money, they did so by increasing efficiency.

The destruction of Michael Milken, Drexel, and a host of other firms and individuals was accomplished by the use of prosecutorial tactics that are the twentieth-century counterparts of the rack. The prosecutors were out to make big names for themselves by bringing down the high and mighty. Many of the convictions were later reversed by the Second Circuit Court of Appeals, but that was back-page news.

Just what was it that Milken had supposedly done? Fischel writes, “After the most thorough investigation of any individual’s business practices in history, the government came up with nothing. In fact, the government never established that Milken’s `crimes’ were anything other than routine business practices common in the industry.”

Milken would eventually plead guilty to six felonies. Four of them were in conjunction with an alleged “stock parking” deal between Milken and Ivan Boesky. Stock parking is a harmless practice whereby one individual purchases and holds securities on behalf of another under an agreement that the true owner will later buy back the stock, taking all gains or losses. The SEC regulates stock parking, however, so that it will not be used to evade other regulations. The so-called crime was over a failure of record-keeping. Such violations had never before been treated as anything but a minor regulatory infraction. Milken had in all probability, Fischel concludes, not even committed the offenses charged. “Felonies” five and six were likewise feeble, more proof that the SEC’s regulation is absurdly overblown than as an attack on the integrity of the financial markets.

If the case against Milken was so weak, why did he plead guilty? The answer is that the government had also indicted Michael’s brother, Lowell, who had no involvement with any of the counts in the indictment, but was used by the government to increase its leverage against Michael. He knew that the government could and would ruin his brother if he didn’t cooperate. One of the most disturbing facts that Fischel brings out is how easy it is for the government to conjure up allegations of securities law violations and use the threat of prosecution to force people’s hands. Guilt isn’t necessary. The prospective financial and emotional costs of a trial are sufficient to bend most people to the government’s will.

After Milken’s coerced guilty plea, numerous demagogic politicians piled on, claiming that he was responsible for the savings and loan crisis that had become a major political and financial debacle by the late ’80s. Milken made the perfect scapegoat. Congress enacted a law forcing remaining S&Ls to divest themselves of ownership of all junk bonds. Fischel’s discussion of the facts of the S&L crisis is excellent, refuting numerous popular myths, and his analysis of the destructive effects of forcing still-solvent S&Ls to dump their junk bond portfolios is razor sharp.

Fischel sums up the campaign against Michael Milken this way: “Milken’s downfall proves only that the government, with its unlimited ability to harass and change the rules in the middle of the game, is more powerful than any individual. . . . The unholy alliance of the displaced establishment and `decade of greed’ rich-haters, aided by ambitious but unscrupulous government lawyers . . . combined to destroy him. The whole episode is a national disgrace.” Read this excellent book and see if you don’t agree.