Status Updates From The Predators' Ball: The In...

And in every recession, cash is accorded its rightful sovereign place in the world of financial instruments. “Salomon had managed to fend (Ronald Perelman) off by selling a substantial stake to Warren Buffett’s Berkshire Hathaway.”

Junk bonds fell about 10% on average, “since they are really part debt, part equity, and their value tends to fluctuate with the equity markets….their key variable being less the direction of interest rates than the perceived ability of the issuer to service its debt.”

After the October 19, 1987 Black Monday crash, “‘debt’ and ‘leverage’ - which had seemed to possess magical properties for the conjuring of enormous wealth in the corporate arena -were demystified, seen as tools of excess”. Recessions follow orgies as Lent follows Fat Tuesday.

Nearly every cult leader develops some form of Stockholm Syndrome with his followers, some love-hate relationship, where they want to leave but believe they can’t, because he holds the keys to their life.

Milken becomes junk bond enforcer as his power and influence grow alongside “opportunities for abuse in the name of control, of expansionism, of disciplining the intransigent, of uprooting the indolent entrenched…it was for the greater good.”
Mostly so that Milken could become greater.

Also, the game of musical chairs was halfway to a Ponzi scheme. Atlantic Capital was using the same strategy that brought down the S&Ls, which borrowed in short three-year stints, and used that new money to pay out on their long-term 10-year loans. No liquidation. If interest rates rise, there won’t be enough to pay on long-term contracts.

Not only did Milken’s investment partnerships operate as “blind pools”, but also “most underwriters who accepted Atlantic Capital bids apparently looked to the AA ratings and not beyond.”

He told polite fictions to the SEC about his partnerships (as a limited investor), either that he didn’t have investment authority for accounts or that he didn’t make investment decisions. One former investment committee member of Otter Creek said, “I never made one decision. It was all Mike.”

He drew an unofficial crowd of loyalists by placing them into other companies, as portfolio managers or investment advisers or hedge fund operators. “By having ostensibly independent managers, Drexel avoided the conflict-of-interest problem it would have had if it had put its own new issues into these funds.”

Milken had a neo-Darwinian approach to the market, repeatedly referring to the resistance of change (“we’re faced with change….we’re not willing to recognize…that many of our money-center banks today are financially weak”). “Often, what’s old is weak and what’s new is strong.” Not the language of good, just power.

He explained the violence of resistance to his clairvoyant outsider stance. “He held himself apart from the mainstream. He had become both prophet and engineer of change.”

As praise piled up, Milken’s latter-day prophecy image ballooned. “Now, after more than a decade of having preached his unorthodox gospel about low-rated bonds, after having pioneered their issuance, eliciting first the disdain and later the antipathy of the corporate establishment, Milken had the certitude of a proven prophet.”

So by fall 1986, even though LTV (with debt underwritten by Lehman) had gone bankrupt, in tandem with savings and loans closures and increased bank failures…plus total national debt was 1.7 GDP or $7 bn (of feds plus other borrowers)….it was okay because debt could be refinanced at lower rates.

Grant pointed toward the slide in quality (“junk was becoming junkier”) as the debt expansion credit cycle grew “from vigilance to recklessness”. The public is elbowing and then punching for “securities of higher and higher yield - and poorer quality”. Junk took a larger chunk of corporate debt, from 11% (1982) to 24% (1985).

Junk deal security deals often heavily favored the zero-coupon bond (no interest payment until maturity). “The day of reckoning for many of these deals, with securities issued in 1985 and 1986, would be years away.” By that time, presumably the company would have recovered enough (or parts sold) to cover that cost.

Some pushed back against Milken’s junk bond empire. 1984, James Grant explains that since the world is long on debt and short on equity, “one should own the thing in short supply and shun the thing in surplus.” Best debt security has “highest ratio of cash flow to interest expense”.

Icahn as master negotiator, exchanging bluffs and double bluffs with a slew of options - “his adversaries often feel they are lost in a maze. The positions he takes are in such flux that for his adversary to try to challenge or attack them is, as one recalls, like ‘wrestling with a ghost’.”

The poison pill explanation - a defense mechanism “triggered by a would-be acquirer’s buying a certain percentage of the target’s stock and gives shareholders such extravagant rights that the company is rendered far less desirable”. Used with recapitalization.