Inside Job by Charles Ferguson Read Free Book Online Page B

He pled guilty, turned informant on Milken and others, and was sentenced to
three years in prison.
    The first wave of junk-bond-backed LBOs was mostly good for the economy. But it didn’t take long for the early deals, plus recovery from the second oil shock, to push up share prices. This
made the early LBOs look insanely profitable, which led to a new wave of LBOs, forcing share prices up even more. Then came greenmail and speculative arbitrage. In the rational,
“efficient” world fantasized by academic economists, buyouts should have tapered off once share prices reached reasonable levels. In the real world, junk bonds created a bubble, both in
the stock market and in the bonds themselves. The Decade of Greed, as it came to be called, lasted until the late 1980s. Once the hysteria broke, collapse rapidly followed. Milken tried to prolong
the bubble by “parking” stock through secret side agreements, and by encouraging self-dealing. His clients would buy junk bonds for their company’s employee retirement plans,
invest in junk bonds with money he raised for them, and so forth. Milken was indicted on more than ninety counts, pled guilty to six, and was sentenced to ten years in prison, fined $600 million,
and banned from the securities industry for life. The fine left him still a billionaire, and he was released from prison after two years. He has since tried to rehabilitate himselfthrough a series of charitable foundations, one of which is now a major source of funding for pro-business academic economists. 5
    The junk bond–LBO-takeover-greenmail-arbitrage craze of the 1980s was a key milestone in Wall Street’s metamorphosis from a tradition-bound enclave to the cocaine-fuelled,
money-drugged, criminalized casino that wreaked global havoc in the 2000s. One major consequence of the LBO craze was to break down the traditional culture of investment banking. LBOs and related
activities required lots of capital, particularly as the size of takeover deals increased to billions, even tens of billions, of dollars. They also were inherently driven by short-term, one-time
transaction fees. So investment banks started to go public to raise capital, pay short-term cash bonuses, and abandon their quaint old notions of ethics and customer loyalty.
    The LBO boom also radically changed Wall Street’s compensation structures, in both structure and size. The bankers on LBO deals soon were paid a percentage of the deal, regardless of
long-term results, and Wall Street salaries soared, as did incomes for the CEOs involved in LBOs, their law firms, their accountants, and their consulting firms. (For several years, Michael Milken
was paid over $500 million per year.) It was the beginning of the shift towards the extraordinary inequality and financial sector wealth we know today.
    Financial Innovation, Derivatives, and the 1987 Market Crash
    THE BOOM ON Wall Street was accompanied by enormous growth in institutional stock portfolios and also by the first wave of the modern IT revolution,
driven by powerful microprocessors and personal computers. The result was the rise of sophisticated computer-driven innovations in portfolio management.
    By the summer of 1987, stock indices had racked up years of spectacular gains, signs of a bubble were everywhere, and institutionalmanagers were nervous. But financial
innovation was there to help, with a marvellous new product called “portfolio insurance”. The idea was this: if a fund manager was worried that the market would fall, he could limit his
losses by selling stock-index futures (a form of financial derivative). If the market suddenly plunged, losses would be covered by the futures you sold.
    Executing such a strategy was impossible for a mere human being, but two University of California at Berkeley finance professors, Hayne Leland and Mark Rubinstein, developed software that would
trade automatically. A portfolio manager could pick a desired price floor, and the