The Predators’ Ball (54 page)

But ultimately this notion had been vetoed as too ignoble, too disloyal to the regent who had made them all richer than they would ever have been without him—and also impractical, since it would have been difficult for the firm to escape liability. Instead, Drexel would present a united front and—unless the government came up with a “smoking gun”—fight back.

Apparently, the closest thing to a smoking gun that the government had was that $5.3 million payment made from Boesky to Drexel in Beverly Hills. And after Boesky's auditors had demanded some documentation, Lowell Milken and Donald Balser had signed the invoice stating the payment was a fee for “consulting and advisory services.” In an article in
The New York Times
in February by James Sterngold, several Drexel executives were quoted, elaborating on this, saying that the payment was for several takeover
bids—for the Financial Corporation of Santa Barbara, Scott and Fetzer, and
U.S. News & World Report
magazine, among others—that Boesky had asked them to work on but had never consummated. One Drexel official added that in some instances Boesky had backed out at the last minute, and that part of the $5.3 million was meant as compensation to Drexel for its work on these deals.

After-the-fact explanations, however, accompanied by no corroborating documentation tend to fall rather flat—particularly when set alongside the “paper trail” of records kept by Boesky which corroborated his version and which the government was said to have collected, according to sources quoted by Stewart and Hertzberg in
The Wall Street Journal.

One Drexel employee claimed that this problem—the lack of a paper trail for their side—had been solved by Drexel's fabricating one. Interviewed in early April '87, this employee claimed that “the books were cooked” in the previous month or so, to show at least one specific charge to Boesky that had never existed, as part of that $5.3 million: about $1 million for research, related to Boesky's abortive takeover bids. If true, this was not only a desperate but an ill-considered gambit, since it appeared somewhat implausible on its face. While Drexel's research has become well regarded in the last couple of years, it was considerably less strong back in 1984, when the work on these bids would have occurred. It is especially unlikely that Boesky, who prided himself on his research capabilities in his own shop, would have paid for Drexel's. Moreover, when Boesky did utilize research from Wall Street firms, he was often given it gratis, in exchange for the commission dollars that the firms earned from his trading.

A Drexel spokesman has stated that contemporaneously with the billing of the $5.3 million fee in March 1986, an internal memorandum directed that the fee be allocated among the corporate-finance, research and high-yield-bond departments, and there have been no subsequent changes.

O
NE YEAR AFTER
Boesky Day, Drexel was still in limbo—its likely indictment spelled out in great detail in the press many months before but not yet issued by any grand jury. In the world at large, however, events had not stood still. On October 19, 1987, the stock market's horrific crash was thought at the time to signal the end of an era—an era in which a five-year surging bull market whipped Wall Street into a frenzy of deal-making, an era in which financial fantasy routinely came true. In the wake of the 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 which might now, in the harsh light of day and a possible recession, exact their toll. The spell—for the moment at least—was broken.

Milken had not created the M&A binge of the eighties. Indeed, he had been an outsider, relegated to the sidelines until he and his colleagues provided their chosen with war chests and refined the concept of the Air Fund (conceived of in a Gobhai seminar but never implemented) into the “highly confident” letter. But once Milken won entry to the game, he did more to shape it than any other individual. It seemed only appropriate, in a sense, that this era might draw to a close now that its impresario was so hamstrung (though by early 1988 M&A would again be thriving and Milken would not yet be enjoined from the scene).

For the past several years, while Drexel and its rivals were underwriting billions of dollars of junk bonds to finance scores of superleveraged acquisitions, critics had predicted that this mountainous
debt's test—and failure—would come in the next recession. They pointed out that in the early eighties' recession the megadeals' junk bonds had not yet existed, and that credit quality of junk had been deteriorating in the last couple of years. Therefore, they maintained, there had been no test of the junk market in its current, $150 billion form.

In the October 1987 crash, junk bonds did fall in price, with the average junk portfolio losing at worst about 10 percent of its value. This was not surprising, since they are really part debt, part equity, and their value tends to fluctuate with the equity markets as much as or more than with the bond markets, their key variable being less the direction of interest rates than the perceived ability of the issuer to service its debt. While investors fled to Treasury bonds, which staged a huge rally as the stock market plunged, junk bonds yielded a near-record 5.5 percentage points over Treasury bonds with comparable maturities. In the weeks after the crash, the market for new junk issues was scarce, even at interest rates of 17–18 percent. And a scattering of obituaries for junk began to appear in the press.

But they were wrong. For by mid-November, one month after the crash, the prices of the stronger junk issues had rebounded dramatically, while the weaker issues—among them credits which were dependent on asset sales to meet their debt obligations, for example—did not. At this point, it was a winnowing out of the junk market, not its demise.

Moreover, the issues and deals that got so badly pounded by the crash that they overnight became symbols of the changed world in junk were by and large not Drexel's. Fruehauf bonds, for example—underwritten by Merrill Lynch—were at 82–84 just before the crash, and two weeks later were at 60–70. Also, in the wake of the crash the Thompson family's management buyout of Southland Corporation was temporarily stalled, mid-deal, when its $1.5 billion of junk bonds could not be sold, even at rates of 18 percent. The investment banks at risk in Southland—at risk because they had been the lead lenders in a $600 million bridge loan extended to Southland the previous August, and now it was not at all clear that the bridge loan could be paid down—were Salomon and Goldman, Sachs. About two months later, however, the Southland deal was restructured to offer investors an added sweetener of warrants, and it proceeded. After the crash, too, bridge loans suddenly lost their panache. They were now seen for what they had always been—serious
risks to the investment banks which had extended them. Drexel had extended some, but had been far charier than most of the other major firms.

Milken rejected the critics' premise that the market had not been tested. Critics, he said in a late-November interview with this reporter, were using the wrong benchmark, because they lacked historical perspective. While it was true that broad public issuance of non-investment-grade securities had started in 1977, he repeatedly emphasized that there had been a large high-yielding market (comprised mainly of fallen angels and paper issued in exchange offers) by 1960. And this market, he asserted, had been tested in 1970–71, and even more severely in both 1974–75 and 1980–81. The success of high-yield investments during these three periods was testimony to the diversity and underlying strength of high-yield companies themselves, Milken added. “We were there to help provide advice and liquidity to both companies and investors during those periods, and we will be again,” he declared. “In reflecting upon it, the greatest opportunity to help, strengthen and build is during difficult economic times.”

By late '87, those difficult times had not yet impacted the rest of the country, but they had hit Wall Street. The retrenchment had started earlier in the year, after several major firms suffered severe trading losses because of interest-rate volatility, but after the crash it proceeded with a vengeance. E. F. Hutton was purchased by Shearson Lehman Brothers. Some specialist firms were bought by Drexel; Merrill Lynch; Bear, Stearns; and others. Layoffs, bonus-cutting, and reduction of overhead expenses were pandemic. Drexel was no exception, though its cuts were less dramatic than some firms'; one hundred of its eleven thousand employees were laid off, and its bonuses were reduced (less so for star performers).

Corporate America, witnessing Wall Street's distress, might have felt a certain mean-spirited gratification. For while hundreds of public companies had undergone paroxysms of restructuring, overhead-cutting, layoffs and elimination of research and development in order to escape an acquirer's clutches, Wall Street, inciter of and handmaiden to all this frantic activity, had only grown fatter. But it could not last; most of the Wall Street firms, after all, had relinquished their private-partnership status over the last decade and become public companies themselves.

Now the scythe had turned in their direction. Salomon, its
earnings down and management poor, had become quarry for Ronald Perelman in August 1987. Salomon had managed to fend him off by selling a substantial stake to Warren Buffett's Berkshire Hathaway. The event served not only as an indicator of Wall Street's vulnerability but also as a reminder of how quickly this world had changed. Exactly two years earlier, the bid for Revlon by the unknown Perelman had seemed, almost, amusing. Now Perelman was a corporate titan to be reckoned with.

Barring an apocalypse—the chain-reaction collapse of dozens of junk-bond-financed, highly leveraged companies, which would then impact the junk portfolios of insurance companies, thrifts, pension funds, mutual funds and others—it will be ten years before Milken's legacy becomes clear. Takeovers, buyouts and restructurings would have occurred if there had been no Michael Milken, but it is hard to imagine that they would have occurred in the size and volume that they did.

And it will take time to discern whether, on balance, those financial maneuvers created leaner, stronger companies, by imposing the discipline of debt, by dismantling inefficient giants and putting their parts into the hands of managers who owned a piece and so did a better job; or whether they created undernourished, nonproductive, noncompetitive companies, crippled by the debt which in many instances had served only to enrich the short-term investors—and, of course, their investment bankers. In all likelihood, both scenarios had occurred, and the question would be which was demonstrably more prevalent.

This, of course, was the debate that had raged through the mideighties. In the speeches Milken gave in 1986, when he was at the zenith of his power, he had risen to it eagerly. Peltz and Perelman, Beatrice and Metromedia, had been his glowing success stories. But by late 1987 the companies that Milken and others at Drexel were pointing to with pride were Comdisco, the computer company; Hovnanian, the successful home-builder; Kinder-Care, the provider of day care (although by late 1987, contrary to Drexel's depiction, the firm was moving into the financial-services area and becoming a buyer of junk bonds). These were all companies which over the last decade had issued junk bonds and used the capital to grow, but not through acquisition, not by doing buyouts. It was as though Milken had entered a time warp; as though he were back in the late seventies and early eighties, raising junk bonds for small
and medium-sized companies that needed capital and couldn't get it anywhere else; as though the last several years of his raising hundreds of millions for the high-rolling entrepreneurs who barely knew what to do with such sums (until he told them), of raising billions of dollars for the biggest, most leveraged acquisitions ever done in the history of this country, had not happened.

The ultimate goal of the massive public-relations campaign Drexel would mount in ads in newspapers and magazines throughout 1987 was to obliterate Drexel's M&A spectacular of 1985–86, to purge the public memory of Drexel's leading role.

In the first few months of 1987, the campaign was more defensive and less focused. Drexel ran one centerfold in
The Wall Street Journal
listing, all in identical tiny print, with no titles, the names of its ten thousand employees, as though to emphasize that there were thousands of other people at Drexel in addition to the ones whose names were appearing regularly in the
Journal's
articles on the government investigation. And in an effort to counter persistent rumors on the Street that it was losing business, Drexel ran ads that listed hundreds of its faithful clients.

But by the spring of 1987, the campaign developed a stronger message—that junk bonds (after years of hating and resisting the nomenclature, Drexel officials had decided there were more important battles to fight) were good for America. Inside the firm there was a two-week-long “celebration,” open to all employees, of seminars, sports events and films, all devoted to this proposition. Thousands of square green pins were distributed, reading: “Junk Bonds Keep America Fit.” (One music video, along more general morale-boosting lines, showed Drexel employees mouthing the words to a hit song by Billy Ocean. “When the going gets tough,” chanted Bob Linton and Fred Joseph along with brokers and mail clerks, “Drexel gets going.”)

The message Drexel was attempting to convey in its in-house and public campaigns was that junk bonds provided the only access to the public debt market for mainstream America—95 percent of American businesses. That the companies that issued them were the vital, growing sector of American industry that had provided new jobs in the last decade, while the employee ranks at investment-grade giants were declining.