Inside Job by Charles Ferguson Read Free Book Online Page A

companies could raise capital by issuing corporate bonds. But years of research convinced an ambitious
young man named Michael Milken that ordinary companies could also do so, and in 1977 he and his employer, the investment bank Drexel Burnham Lambert, began to underwrite bond issues for previously
unrated companies. Interest rates were higher than in the blue-chip bond market but compared favourably with bank loans. Initially, the availability of so-called junk bonds was a useful service to
midsize companies that needed capital for growth. But then things went crazy.
    What happened first was that predatory investment firms started to use junk bonds to buy companies. This often made financial sense, for two reasons. First, the stock market had fallen so
severely, and often irrationally, that many public companies were cheap to acquire—if you had the cash, which the junk bond market provided. But the second reason for the junk bond boom was
that many companies were grotesquelymismanaged by complacent, entrenched executives. Until junk bonds, they had nothing to fear, because they were supported by their equally
complacent, entrenched boards of directors.
    But then, suddenly, there was a way to get rid of entrenched management, even if the board supported them. Someone could go to Michael Milken and, nearly instantly, raise billions of dollars on
the junk bond market to finance a hostile takeover. In some early cases, this produced real efficiencies as incompetent managers were forced out by new owners. But then the financiers noticed two
important things. The first was that once they took over a company, they could do anything they wanted. They could break the company up, sell off its pieces, cut employee benefits, pay themselves
huge fees, and, quite often, loot whatever remained. They could also “flip” the company. Early in the leveraged buyout (LBO) cycle, the stock market was severely depressed. But as the
market started to recover in the 1980s, it became almost trivial to buy a company in an LBO, cut some expenses, and take it public a few years later.
    William Simon, Treasury secretary in the Nixon and Ford governments, put up $1 million of his own money and borrowed another $80 million to buy Gibson Greeting Cards in 1982. Less than a year
and a half later, with a stock market recovery under way, he took the company public at a value of $290 million. Ted Forstmann’s firm even more spectacularly bought and flipped Dr Pepper. The
simplicity and profitability of the early deals led to a bubble, one that Michael Milken and his friends then perpetuated, of which more shortly.
    But the financiers’ next insight was much more fun. They realized that actually, they didn’t even need to buy the company, and then go through all the messy work of fixing it,
running it, selling it. All they needed to do instead was to threaten to buy the company. In response, the company’s terrified, inept executives and board of directors would pay them
enormous sums simply to go away. And thus was born “greenmail”. Michael Milken and Drexel’s junk bonds started to finance greenmail on a large scale, which was primarily conductedthrough specialized firms created by the likes of business magnates T. Boone Pickens, Ronald Perelman, and Carl Icahn.
    Milken and his junk bonds also financed a number of the most corrupt S&Ls, as well as the arbitrageurs, or “arbs”, who gambled on the existence and outcome of takeover battles.
Of course, making money that way was a lot easier if you actually knew what was about to happen, so the rise of LBOs, greenmail, and speculative arbitrage also caused an epidemic of insider
trading. People like Ivan Boesky developed networks of informants and paid serious bribe money for leaks; Boesky would then raise money through Milken, buy stock, and sell it as soon as the
takeover was initiated or completed. Boesky made a fortune, but in 1986 the SEC and government prosecutors nailed him.