High Rollers On the Downside

Another vestige of the Reagan era went the way of the hula hoop this February when the investment banking firm of Drexel Burnham Lambert declared bankruptcy. Drexel et al. was, in more prosperous times, the home base for Wall Street megabucks hustler extraordinaire Michael Milken. In the mid-to-late '80s, under Milken's leadership, Drexel was at the white-hot center of the Wall Street action from which emanated such quintessentially '80s fads as junk bonds, leveraged buyouts, and insider trading.

It was the latter, a form of outright fraud -- even in the deregulated age -- that finally brought Drexel down. Ivan Boesky turned one last big deal with the feds and fingered his buddy Milken for 98 counts of illegal market manipulation. The criminal case finally deprived Drexel's decade-long con game of its crucial ingredient: investor confidence. Suddenly the paper stopped moving. The debts went unserviced. And the deal went down.

The demise of Drexel probably drives the last stake through the heart of the speculative junk bond market. But the economic damage from those heady, bubbly days of fast talk and fast money will linger throughout the new decade.

Junk bonds are just what they sound like: pieces of paper, of dubious value, that promise the bearer a certain number of dollars at the end of a certain period of time. Traditionally bonds are issued by governments or other large institutions to provide long-term capital for major projects. Such bonds are considered one of the safest available forms of "evidence." Compared to traditional investment-grade bonds, the junkers matured quickly and promised to pay off big.

The junk bond market came about because Reagan-era deregulation opened the way for investment institutions to enter into riskier terrain. The tax law provided incentives for companies to replace stock ownership with bond indebtedness because interest payments are non-taxable. And the financial incentives to investment bankers -- the commissions on the sale of the bonds -- are overwhelming. Michael Milken alone, before his fortunes turned, amassed personal wealth to the tune of $1.2 billion.

Junk bonds are most commonly issued to fund corporate takeover and buyout deals. Because they carry a higher risk than traditional bonds, they also promise a much higher and quicker return on investment. This makes junk bonds, as a means of financing business activities, a very expensive proposition for the issuing company. Thus, when a junk bond-financed takeover deal is finished, the new owners often, like drug addicts with a new inheritance, begin immediately to sell off company assets to provide the cash to service the debt.

Once the most valuable assets are stripped, deeply indebted managers start cutting expenses by laying off workers and slashing expenditures for things such as research and development, which, while necessary for the long-term health of any manufacturing firm, are a drain on the all-important cash flow. Junk bond indebtedness helps shorten the sights of corporate America even further. Managers move from an obsession with the quarterly profit statement to a fixation on meeting the monthly finance charges.

SO THE LATE DREXEL BURNHAM Lambert changed the way America does business, and for the worse. The junk-fueled takeover fever contributed greatly to the Reagan era's terminal deterioration of America's manufacturing base and the accompanying wholesale corporate abandonment of workers and communities. Not only do people not count anymore, but products don't either. The only thing that counts in Milken and Co.'s brave new world is to cut the deal, move the paper, and collect the commission.

During the course of the '80s, American corporations amassed a debt of approximately $1 trillion. Of this figure, $200 billion is in junk bonds. In the market's confident days, Milken was forecasting a junk bond default rate of no more than 2 percent per year. Follow-up research has shown annual defaults running at something closer to 19 percent and rising. Fully half of the investment capital of the 10 largest U.S.-based banks is tied up in junk-ridden corporate buyout deals.

The economic growth of the Reagan era was fueled by debt -- governmental and corporate. Debt is not in itself a bad thing. If a firm, or a government, assumes a heavy debt load in order to buy new equipment, develop new technologies, or retrain the workforce, then debt can be a good thing for the health of the firm and the society.

But the '80s debtor economy did not serve any such useful social goals. Instead the debt served to fund an orgy of speculative wheeling and dealing. As a result, heading into the '90s, our economy looks more and more like a house of cards, and a heavily mortgaged one at that. The fall of Drexel Burnham Lambert is simply one more early indication of just how shaky that structure has become.

Danny Duncan Collum is a Sojourners contributing editor.