Robert Teitelman tells the stories of Felix Rohatyn, Bruce Wasserstein, Michael Milken in Bloodsport
The political significance of Michael Milken’s junk-bond insurrection was not obvious to the world outside Wilshire Boulevard, Beverly Hills, where his Drexel Burnham Lambert high-yield—that is, junk-bond—department operated, until he decided to take over M&A. That was in the mid-’80s. Throughout the ’70s and into the ’80s, Milken built his sales and trading operation with intense, monomaniacal energy and did it outside the public eye. He saw no need for the press. He was, to an extraordinary extent, a furtive creature of the markets, not a public figure. He was a control freak, a workaholic, and still young, at 39, in 1985. He was a man who kept his information close, including a few items that probably weren’t secrets to his colleagues, like his toupee, which he donned in his twenties. All that ended with Drexel’s decision to join the takeover wars in 1985.
Milken had grown up, the son of an accountant, in Southern California, and like a character from Ozzie and Harriet—a common reference in Milken profiles—he was a high school cheerleader (Sally Field was on the squad, too) and prom chairman and he worked in a diner. He neither smoked nor drank nor indulged in recreational drugs nor sipped caffeinated or carbonated beverages. He attended the University of California at Berkeley during the free-speech movement, joined a fraternity, was elected to Phi Beta Kappa, then went to the University of Pennsylvania’s Wharton School, graduating in 1970. He appeared untouched by political events: he was a finance junkie, which in those days was a more unusual preoccupation than it is today. At Berkeley or Wharton—accounts vary—he stumbled across, like Joseph Smith in the New York woods, his golden plates: bond studies going back to 1900 by W. Braddock Hickman, an economist at Princeton and Rutgers universities.
Hickman’s study (later updated by T. R. Atkinson to the year 1965) argued that over time those bonds, which carried higher interest rates than investment-grade corporate bonds, generated better risk-adjusted returns than more traditional fixed-income portfolios. In other words, the higher rate more than compensated for the greater risk. This was Milken’s revelation: investment grade, he repeated endlessly, could only go down. Junk had upside. Milken saw his bonds as speculative tools; he was a trader. Investment grade rarely went bankrupt, which meant bondholders got paid; junk did, at varying levels, which meant investors maybe didn’t. This is where the debate over junk really began.
“Adam Smith,” the pseudonym of a financial writer named Jerry Goodman, was pondering go-go financial truths around the time Milken was leafing through Hickman. One of his themes in The Money Game, an iconic text in modern financial journalism published in that gloomy year, 1976, was the increasing fixation on calculating value as Wall Street was emerging from what he called its long, post–Black Friday purgatory, “the Street of iniquity.” Goodman recognized it was an age that increasingly saw salvation in quantification and rational models and that attempted to eliminate experiences that were not reducible to numbers. Milken believed he had discovered the key in patterns of junk-bond defaults and returns. But his larger tale, his personal story, particularly when it came to M&A, shared many aspects with what Goodman claimed his book was all about: “image and reality and identity and anxiety and money.”
Milken went to work at a triple-barreled firm on a respirator, Drexel Harriman Ripley, in Philadelphia, a partnership launched in 1835 with a deep Wasp genealogy, which included an ancestor he would later be compared to: J. P. Morgan Sr., who had worked there when it was his father’s firm, Drexel Morgan. In 1971, the then–Drexel Firestone underwent a shotgun merger with a second-tier, New York retail brokerage, Burnham & Co., run by Isaac Wolf “Tubby” Burnham II. Connie Bruck, in her definitive Milken book, The Predator’s Ball, has Burnham, who was Jewish, asking his Drexel counterpart if he employed any Jews. He did: 3 or 4 out of 250, including a brilliant one, he said, who would probably leave—Milken.
Burnham, who had borrowed $100,000 from his grandfather to start the firm in 1935 and was not really overweight (the nickname was a vestige of a childhood illness), talked to Milken and asked what he required to stay. More capital, he replied; Drexel had been starving his tiny trading operation for capital. Burnham gave him $2 million to play with. He also appended the ritzy Drexel name in front of the more plebian Burnham on the all-but-inarguable advice of Goldman Sachs’s Gus Levy and Morgan Stanley’s Robert Baldwin. Drexel Burnham. Burnham’s mother complained about that decision, but the newly christened Drexel Burnham celebrated by ordering up Lucite “tombstones” containing two brass balls each.
By then, Milken had already begun to build a desk that traded these low-rated bonds. Milken dealt with bonds from once-solid companies that had come down in the world—“fallen angels”—or (less often) “Chinese paper,” issued by conglomerates in acquisitions. Years later, he opened up huge new markets in debt for emerging companies, for leveraged buyouts, and for hostile takeovers—very different from the bonds Hickman studied. Early on, Milken traveled the country, like Johnny Appleseed, making a case for his low-grade bonds. Milken was a shining example of that emerging business species he did so much to ennoble, the entrepreneur, breathing as much life into that out-of-favor concept as he did into these zombified junk bonds. (Milken’s rise roughly paralleled that prototypical New Age entrepreneur, Steve Jobs—another figure who made a vast amount of money by claiming he wasn’t interested in money.)
He started out trading but he had bigger plans. In 1972 he convinced his first major investor, a pension plan for an industrial company, to buy a 5 percent allocation of junk; conventional bond funds then gobbled up junk from Milken to make up for steep losses in the oil crisis and the subsequent slump in the economy in 1974; in 1977, he launched his first junk-bond fund, tapped insurers, money managers, and S&Ls desperate for yield, and began issuing new bonds, all the while building widening circles of unorthodox financiers—entrepreneurs—who were both buyers and sellers of his bonds: Meshulum Riklis, Saul Steinberg, Steve Wynn, Victor Posner, the Belzberg Brothers, Carl Lindner, William Farley, Fred Carr, and Tom Spiegel; later, John Malone, Craig McCaw, Steve Wynn, Ted Turner, Nelson Peltz, Ronald Perelman, Icahn, Pickens, and the LBOers.
In 1978, Milken, then 32, took his entire operation and moved it to Los Angeles. Explanations have proliferated about that exodus. He and his wife had grown up in the San Fernando Valley; he wanted to spend more time with his three children; his father was sick. He could get a three-hour jump on New York by starting every day at 4 a.m. Investment banker Bruce Wasserstein, in his book Big Deal, says Milken left to avoid “the watchful eyes of competitors,” which may tell more about Wasserstein than Milken. Bruck talks about how he resisted prying questions from senior executives at Drexel. One of those execs was Burnham, then closing in on 70. The much-younger man’s aggressiveness and penchant for secrecy worried Burnham, who had grown up in an age when capital was dear, liquidity could disappear like water in a colander, and disaster was always in the forecast.
Milken believed that the money world had changed; he had changed it. Junk released powerful energies. Money was flowing, liquidity abundant, risk at bay, despite the ‘70s gloom. (Goodman as Adam Smith: “The one thing we have, whether or not we will ever find true Value, is liquidity—the ability to buy and sell momentarily and relatively effortlessly. Liquidity is the cornerstone of Wall Street.” Liquidity was related to but not the same as jingling, crackling money-in-your-pocket. A liquid cornerstone may be a sly Smithian joke.) Six years later, in 1984, Drexel would run an ad campaign with the tag line “How to Invent Money.” The two worldviews—scarcity and abundance, the dead past and the lively future—clashed. So Milken put a continent between himself and New York.
In the early years, Milken had commuted in the pitch-black of an early-morning bus from Cherry Hill, NJ, to Drexel Burnham on Wall Street, poring over bond data wearing a miner’s cap with a light. (The detail comes from Bruck. Just before publishing her book, a group of Drexel insiders gathered to read it. Richard Sandler, an old Milken colleague, erupted over the miner’s cap anecdote. “It was a gift. It was an eye doctor’s thing. He never wore it; he only wore it once.” Bruck never revised.) The miner’s cap packed a metaphorical punch: this intense guy with the burning eyes was peering into the dark—literally and figuratively.
It wasn’t just that Milken, like Flom in his proxy days, operated in an arena that was so marginal as to be almost invisible to much of American business, but that his bonds were considered lost, fallen, tainted, cast into stygian gloom.
In retrospect, the fact that Milken could retrieve and resuscitate these bonds was one of many consequences of broadly rising American financial wealth. There was enough money—liquidity—around to jolt junk to life, and there was a feedback loop attached: once launched, Milken’s junk network turned synergistic. Bonds, one form of debt, had once been the primary currency of a capital-poor, risk-averse financial world, the prudent man’s investment (many a Wasp fortune sat upon a mound of corporate bonds); by the time Milken came along, in the ’60s, the upside appeal of stocks had made bonds appear dull, dusty, antiquated; institutions were buying stocks.
In M&A, bonds generally had, at best, marginal standing. Or worse. Even loans, another form of debt, were senior to bonds in the capital structure: banks got paid before bondholders. And as deals grew more leveraged (that is, featured more debt) and complex, bondholders often found the value of their bonds beaten down as new loans and debt were piled atop them. Bondholders were creditors possessing an explicitly contractual relationship with the firm.
Unlike shareholders, who were corporate owners or principals, bondholders existed in a netherworld, more agent than principal. Bondholders were not party to the elemental struggle between managers and shareholders. They were not within the ambit of fiduciary duties (except to their own investors). Beyond contractual details, bonds and bondholders, like loans and lenders, were not thought of as actors in the daily drama of corporate governance.
Milken changed all that. Milken made the issuance and use of junk bonds (he invented the term until some genius realized it sounded bad, high-yield was rolled out, and critics were then ritually castigated for using the term junk) an essential step in financing a new company or engineering a hostile takeover. American companies, Milken believed, were underleveraged: too little debt. Debt got a nifty tax deduction. And debt forced agents to serve principals, a concept Jensen would soon embrace.
Debt was, in the phrase from James Grant of Grant’s Interest Rate Observer, “the new Archimedes lever.” Milken’s junk broke the stranglehold that equity financing had held over companies. The only “real” company had been assumed to be a public company. A public listing brought with it shareholders, thousands of them, of all varieties, and thus produced the separation of ownership and control. Traditionally, financing of private companies was perilous and scarce—mostly bank loans and the odd angel investor. Junk provided fresh sources of capital.
Bonds had their complexities and compliance issues, but they were, by definition, private and ownership and control were direct, aligned, undivided, unambiguous. The SEC was more remote from bonds. A company financed by bonds—which increasingly meant Milken’s bonds—could retain its privacy, entrepreneurial freedom, and creativity, while avoiding the governance challenge of shareholders who owned but didn’t monitor and a government that regulated, taxed, and harassed. And joining Milken’s magic circle also provided protection from attack. Bonds, in short, were the instruments of a new entrepreneurial age.
Editor’s Note: Michael Milken was caught up in the insider trading scandals in the late ‘80s, went to prison for securities violations and now runs the Milken Family Foundation and the Milken Institute in Los Angeles. Drexel Burnham Lambert filed for bankruptcy in 1990.
Robert Teitelman has worked in financial journalism for 25 years. He was the founding editor-in-chief of The Deal. Previously, he was a writer for Forbes and the editor of Institutional Investor. This article is an excerpt from Bloodsport: When Ruthless Dealmakers, Shrewd Ideologues, and Brawling Lawyers Toppled the Corporate Establishment, published in April by PublicAffairs. Reprinted with permission from PublicAffairs.