junk bonds

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The Predators' Ball: The Inside Story of Drexel Burnham and the Rise of the JunkBond Raiders by Connie Bruck

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", Alvin Toffler, Bear Stearns, book value, Carl Icahn, corporate raider, diversified portfolio, Edward Thorp, financial independence, fixed income, Future Shock, Glass-Steagall Act, Irwin Jacobs, junk bonds, Michael Milken, mortgage debt, offshore financial centre, Oscar Wyatt, paper trading, profit maximization, Tax Reform Act of 1986, The Predators' Ball, yield management, Yogi Berra, zero-coupon bond

If the issuer understands at the time of his offering that he will pay the piper by buying other junk bonds, this ought to be disclosed in the prospectus. To Revlon’s allegation, Perelman’s response was simply that after getting the money he had decided to invest some of the proceeds from the offering—about $350 million, in fact—in other Drexel-underwritten junk bonds, in order to make up his carrying cost, of about 14.5 percent. According to Gittis, they had told many investment-banking firms that they were in the market for junk bonds, but only Drexel had available the quantity that they wanted. “We started hearing that others were trying to buy them from Drexel, to sell to us.”

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That loan in effect “bridges” the time from the closing of the deal to the time when the junk bonds are sold; the proceeds of the sale then pay off the loan or (if the investment bank is leaving some of its capital in the deal) part of it. In their enthusiasm, Salomon and a group of institutional lenders who were participating in thus funding deals together dubbed themselves “the Bridge Club.” It was inevitable, once these firms—tantalized by those 3–4 percent spreads—had followed Milken into the original issuance of junk bonds, that they would then attempt to follow him the next step: to the junk-bond-financed takeover and buyout. How could they not try, after watching Drexel garner a financing fee of $86 million in the Beatrice buyout?

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At first, Wirth spearheaded the congressional assault; but by April 1985, when he attended the Predators’ Ball, he was straddling the fence, and by the end of that year he had become a staunch supporter of Drexel and its junk bonds. In fact, one of his top aides, David Aylward, left his job with Wirth to help organize Alliance for Capital Access, a lobby formed to oppose federal limits on junk-bond financings, formed by Drexel clients at Drexel’s prompting. The leader of Alliance was Larry Mizel of M.D.C. Holdings, a longtime issuer of junk bonds and also a major subscriber to the bonds in the takeover deals. Under the Federal Election Campaign Act, the limits on contributions to candidates per election are $1,000 for a contribution by an individual and $5,000 by a multicandidate committee (the category in which Drexel’s Political Action Committee falls).

Liar's Poker by Michael Lewis

barriers to entry, Bear Stearns, Bonfire of the Vanities, business cycle, Carl Icahn, cognitive dissonance, corporate governance, corporate raider, disinformation, financial independence, financial innovation, fixed income, Glass-Steagall Act, Home mortgage interest deduction, interest rate swap, Irwin Jacobs, John Meriwether, junk bonds, London Interbank Offered Rate, low interest rates, margin call, Michael Milken, mortgage tax deduction, nuclear winter, Ponzi scheme, risk free rate, The Predators' Ball, yield curve

Many of us also asked our first questions about the wisdom of entering the junk bond market. With the stock market crash the market in junk bonds, inextricably linked to the asset values of corporations, temporarily ceased to function altogether. The fickle stock market was saying that one day corporate America was worth $1.2 trillion, and the next only $800 billion. Junk bond investors dumped their holdings when they saw the wild behavior of their collateral. Our Southland junk bond deal collapsed on October 19. When the stock market crashed, the value of 7-Eleven stores and, therefore, junk bonds backed by 7-Eleven stores, crashed, too.

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Lewie Ranieri feared losing his grip on Salomon Brothers' savings and loan customers and found a couple of ways to foil the small, fledgling junk bond department created by Voute in 1981. In 1984 our two-man junk bond department spoke at a Salomon Brothers seminar for several hundred savings and loan managers. They had been invited to address the thrifts by the mortgage department. But after their three-hour presentation, Ranieri rose to deliver the closing address. The customers, of course, hung on his every word; as I've said, they viewed Lewie as their savior. "There are two things you absolutely should never do," said Ranieri. "And the first is buy junk bonds. Junk bonds are dangerous." Of course, he might have believed it.

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In the end, however, the thrifts did not, and Ranieri's objection served only to discredit Salomon's junk bond department and drive the thrifts into the arms of Drexel. And Bill Voute's people were livid about being humiliated before such an important audience. "It was sort of like being invited to dinner and finding out you're the dinner," says one former Salomon junk bond man. The same two-man team of junk bond specialists spent six months crossing America making presentations to individual S&L managers. "It was a crackerjack presentation, and we were getting a great response, but no one was calling up to buy bonds," says one of the Salomon former junk bond specialists. They expected that the orders to buy junk bonds would soon follow their road show.

Den of Thieves by James B. Stewart

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", Bear Stearns, Black Monday: stock market crash in 1987, book value, Carl Icahn, corporate raider, creative destruction, deal flow, discounted cash flows, diversified portfolio, fixed income, fudge factor, George Gilder, index arbitrage, Internet Archive, Irwin Jacobs, junk bonds, margin call, Michael Milken, money market fund, Oscar Wyatt, Ponzi scheme, rolodex, Ronald Reagan, Savings and loan crisis, shareholder value, South Sea Bubble, Tax Reform Act of 1986, The Predators' Ball, walking around money, zero-coupon bond

It would be an unprecedented test of the degree to which public opinion could be used to shape the outcome of a criminal investigation. Soon after the junk-bond conference, Drexel launched a two-week-long, firm-wide celebration of junk bonds, including sporting events, lectures, and films touting the glories of junk bonds and their contributions to America. In a policy shift first announced at the conference, Drexel abandoned its long-standing eflforts to replace the word "junk" with "high-yield" in popular parlance. Instead, it decided to embrace "junk." Employees were given pins with the message, junk BONDS KEEP AMERICA FIT. One of the videos featured Joseph and firm chairman Robert Linton lip-synching the lyrics, "When the going gets tough, Drexel gets going."

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It would be enormously lucrative for Drexel; on top of its investment banking advisory fees, it would raise over $150 million in Milken-led junk bonds, skimming oflf its usual percentage, or about $5 to $6 million in financing fees alone. And this wasn't all. The true extent of Milken's gains were concealed in the closely guarded partnership accounts in Beverly Hills. The Milken-led investment partnerships, originally launched to free his junk bond people from worrying about their own investments, had been thriving, moving Drexel-underwritten junk bonds in and out of their portfolios at large spreads, buying positions at favorable oflfering prices that quickly soared once trading in the bonds began after the offer.

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One of the videos featured Joseph and firm chairman Robert Linton lip-synching the lyrics, "When the going gets tough, Drexel gets going." Full-page newspaper ads showed alleged beneficiaries of junk-bond largesse: not, of course, people like Milken himself, or Milken satellites like Carr or Spiegel, but a wholesome young man, his pregnant wife and their child standing in front of a soon-to-be-completed new home. What linked this scene of happy domesticity to junk bonds? Hovanian, the home's builder, was a Drexel client that, with junk bonds, had been able to "provide 50,000 people with a living room and 20,000 people with a living," the ad claimed. A $4 million network television campaign was similarly sentimental, showing an energy plant in Vidalia, Louisiana, built with Drexel junk bonds, that had supposedly lowered unemployment in the impoverished Louisiana town.

Barbarians at the Gate: The Fall of RJR Nabisco by Bryan Burrough, John Helyar

Alan Greenspan, Bear Stearns, Black Monday: stock market crash in 1987, buy and hold, buy low sell high, Carl Icahn, corporate raider, Donald Trump, financial engineering, Gordon Gekko, junk bonds, margin call, Michael Milken, Ronald Reagan, Rubik’s Cube, shareholder value, South Sea Bubble

Sooner or later, Forstmann knew, the economy would turn down and all the junk-bond junkies would go belly-up when they couldn’t make their mountainous debt payments. They were like those “no-money-down” real estate investors with no money in their pockets when their debts came due. When that happened, Forstmann feared, the use of junk-bond debt would be so widespread that the entire U.S. economy might be dragged into a depression. Of all Drexel’s junk-bond clients, by far the most nettlesome to Forstmann was his archrival Kohlberg Kravis. Kravis not only used more junk bonds than any other, but it did so in Forstmann Little’s front yard, the LBO industry.

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But Perelman won out when a Delaware court, in a precedent-setting move, ruled that key components of Forstmann’s merger agreement unfairly discriminated against Pantry Pride. Revlon was the first hostile takeover of a major public company by a junk-bond-backed buyer, and it opened the gates for a string of similar battles, including a string of attacks by raiders such as Paul Bilzerian and Sir James Goldsmith. In an odd way, Ted Forstmann held himself responsible for the carnage junk-bond-financed raiders wrought on Corporate America. The triumph of junk bonds was more than an affront to Forstmann’s morals, of course. It was laying waste to his business as well. Because the use of junk bonds allowed corporate raiders to raise money cheaply and easily, it tended to drive up the prices of takeover targets.

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For fifteen months Good’s clients kept fees pouring into Cohen’s coffers, as Shearson backed raids on several companies, including Burlington Industries and Telex. Over time, though, Cohen began to lose confidence in Good. The sale of junk bonds is normally among the most profitable aspects of merchant banking. But because Good’s raiders rarely bought anything, Shearson’s junk-bond department sat idle, atrophying. When Asher Edelman finally managed to snag a company—the steakhouse chain, Ponderosa—Shearson’s junk-bond offering was a disaster, and the firm took steep losses. Cohen steamed. Good took the blame. The final run of Shearson’s raider express began on Black Monday, October 19, 1987.

Phishing for Phools: The Economics of Manipulation and Deception by George A. Akerlof, Robert J. Shiller, Stanley B Resor Professor Of Economics Robert J Shiller

Andrei Shleifer, asset-backed security, Bear Stearns, behavioural economics, Bernie Madoff, business cycle, Capital in the Twenty-First Century by Thomas Piketty, Carl Icahn, collapse of Lehman Brothers, compensation consultant, corporate raider, Credit Default Swap, Daniel Kahneman / Amos Tversky, dark matter, David Brooks, desegregation, en.wikipedia.org, endowment effect, equity premium, financial intermediation, financial thriller, fixed income, full employment, George Akerlof, greed is good, income per capita, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, junk bonds, Kenneth Arrow, Kenneth Rogoff, late fees, loss aversion, market bubble, Menlo Park, mental accounting, Michael Milken, Milgram experiment, money market fund, moral hazard, new economy, Pareto efficiency, Paul Samuelson, payday loans, Ponzi scheme, profit motive, publication bias, Ralph Nader, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, short selling, Silicon Valley, stock buybacks, the new new thing, The Predators' Ball, the scientific method, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, theory of mind, Thorstein Veblen, too big to fail, transaction costs, Unsafe at Any Speed, Upton Sinclair, Vanguard fund, Vilfredo Pareto, wage slave

Apples would be the “fallen angels” issued by once-successful companies down on their luck; those were the kind of junk bonds studied by Hickman. The prunes would be the new kind of junk bonds, which Milken would make happen. The fallenangel junk bonds had indeed done surprisingly well up to 1943. The challenge for Milken as phisherman was to find a way to profit from this error by creating another kind of junk bond: not a fallen-angel junk bond, but a newly issued junk bond, with himself as the broker of the new issue. The Milken story unfolds as he takes his first job after graduation from Berkeley and an MBA at the Wharton School of Business.

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His salesmanship resulted in the popular name junk bond for the low-grade debt, although Milken himself avoided using it. By 1975 the Wall Street Journal published an approving front-page article about Milken: “One Man’s Junk Is Another’s Bonanza.” Bond trading, it said, had become “the fastest game in town.”6 Milken had become a superstar. And he was only five years out of graduate school. People commonly make the fallacy, in the words of John Locke, of “taking words for things.”7 In this case, the mistake could be assuming that junk bonds from one decade are the same as junk bonds from another. They have the same name, junk bonds, and so phoolish investors can be expected to react the same to them, even if this time they are underwritten by institutions whose reputations are being mined.

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Instead, they would be daisy chains of mortgage valuations: the kite in the valuations fenced through overrated mortgage-backed securities. The next chapter shows how the looting of the S&Ls metastasized into the market for junk bonds in the beginning of our new age of greed. Soon-to-be-bankrupt S&Ls played a significant role in the expansion of the market for junk bonds, which underlay hostile takeovers of even the largest firms—previously deemed impossible. TEN Michael Milken Phishes with Junk Bonds as Bait The work of one man, Michael Milken, in the 1970s and 1980s changed the face of US finance forever. No longer could corporate executives of large US corporations be confident that their companies were too big to be challenged by corporate raiders threatening hostile takeovers because now the raiders could acquire even very large companies without putting up much capital.

The Best Way to Rob a Bank Is to Own One: How Corporate Executives and Politicians Looted the S&L Industry by William K. Black

accounting loophole / creative accounting, affirmative action, Alan Greenspan, Andrei Shleifer, Black Monday: stock market crash in 1987, book value, business climate, cognitive dissonance, corporate governance, corporate raider, Donald Trump, fear of failure, financial deregulation, friendly fire, George Akerlof, hiring and firing, junk bonds, margin call, market bubble, Michael Milken, money market fund, moral hazard, offshore financial centre, Ponzi scheme, race to the bottom, Ronald Reagan, Savings and loan crisis, short selling, The Market for Lemons, transaction costs

Milken sold, as I noted, $125 million in ACC sub debt at a high interest rate to the usual subjects: if Milken sold one’s junk bonds, it was understood that one bought junk bonds issued by other Milken clients. The key to Milken’s scheme was to reduce the apparent default rate, so it would not do to let ACC default on its Drexel-issued junk bonds. The situation was as elegant as it was cynical: ACC would sell junk bonds to widows (at a ludicrously low rate of interest) and use the proceeds to retire the Drexel-issued junk bonds sold (at a very high rate of interest) to Milken’s minions.10 This scam simultaneously (1) avoided a default on Drexel-issued junk bonds, (2) considerably reduced ACC’s interest expense, and (3) allowed ACC to book a gain from refinancing its debt at a lower interest rate.

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He was deeply suspicious of Milken and wanted to pass rules restricting junk bonds. OPER, however, said they could not support the rule. In this era, even the GAO’s economists opined that junk bonds were an excellent investment (Stein 1992, 134–135). According to OPER, Milken was right: a diversified pool of junk bonds made a superior investment portfolio. Fortunately, S&Ls never held more than 10 percent of outstanding junk bonds (and usually far less), and 90 percent of all those junk bonds were held by a dozen S&Ls, all of which failed (Black 1993c; NCFIRRE 1993, 4). Many at the agency saw Lincoln’s billion-dollar portfolio of junk bonds as a warning sign, but OPER did not.

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The more subtle advantage was that Milken’s control of the captives ensured that public offerings of junk bonds would succeed and that junk bonds issued by Drexel that were about to default would instead be restructured. Milken could cause the captives to purchase whatever junk bonds the market had refused to buy or restructure (Akerlof and Romer 1993). Reducing the reported default rate of a security makes it appear less risky; a bond that appears less risky rises in value. This is not a claim that Drexel ran a Ponzi scheme or that junk bonds were worthless. They were, however, materially overvalued. That made Milken a rich man, even after he was released from prison.

Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present by Jeff Madrick

Abraham Maslow, accounting loophole / creative accounting, Alan Greenspan, AOL-Time Warner, Asian financial crisis, bank run, Bear Stearns, book value, Bretton Woods, business cycle, capital controls, Carl Icahn, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, desegregation, disintermediation, diversified portfolio, Donald Trump, financial deregulation, fixed income, floating exchange rates, Frederick Winslow Taylor, full employment, George Akerlof, Glass-Steagall Act, Greenspan put, Hyman Minsky, income inequality, index fund, inflation targeting, inventory management, invisible hand, John Bogle, John Meriwether, junk bonds, Kitchen Debate, laissez-faire capitalism, locking in a profit, Long Term Capital Management, low interest rates, market bubble, Mary Meeker, Michael Milken, minimum wage unemployment, MITM: man-in-the-middle, Money creation, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, new economy, Nixon triggered the end of the Bretton Woods system, North Sea oil, Northern Rock, oil shock, Paul Samuelson, Philip Mirowski, Phillips curve, price stability, quantitative easing, Ralph Nader, rent control, road to serfdom, Robert Bork, Robert Shiller, Ronald Coase, Ronald Reagan, Ronald Reagan: Tear down this wall, scientific management, shareholder value, short selling, Silicon Valley, Simon Kuznets, tail risk, Tax Reform Act of 1986, technology bubble, Telecommunications Act of 1996, The Chicago School, The Great Moderation, too big to fail, union organizing, V2 rocket, value at risk, Vanguard fund, War on Poverty, Washington Consensus, Y2K, Yom Kippur War

In the late 1970s, both Riklis and Steinberg eventually had to sign consent decrees with the SEC, neither admitting nor denying guilt on charges of financial misconduct, but agreeing to discontinue the practices. Milken’s junk bonds were severely tested in the 1973–1975 recession, and most held up. When the economic expansion started in 1975 and 1976 again, the junk bond issuers generated more cash flow and many investors made handsome profits on the bonds’ rise in value. Junk bonds began to look more like trustworthy investments to a widening circle of investors. Milken had mostly traded in the fallen bonds of once healthy companies. Now he wanted to expand his business into investment banking by underwriting new issues of junk bonds for risky companies. In the past, such companies had to borrow from banks or insurance companies—loans that were heavily collateralized by assets or capital and almost always hard to get.

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In doing so, he became by far the richest man on Wall Street at his peak, almost single-handedly creating and controlling a $200 billion market for junk bonds—the high-interest-paying debt of risky companies. No single person ever wielded as much power in the post–World War II period. By 1988, junk bonds amounted to one fourth of outstanding corporate debt. Three fifths of it was for takeover transactions of one kind or another. Milken had enormous influence over both buyers and sellers, and this enabled him to set the prices of the junk bond debt. He took a piece of these deals every step of the way, often secretly. Even when other major investment banks were competing with him, Milken typically controlled well more than half the market.

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Once out of prison, he started a charitable foundation dedicated to economic research and contributed significantly to medical research, having survived prostate cancer. By the time of Milken’s plea in the spring of 1990, the junk bond market was collapsing. Deals financed by Milken and others had now clearly been done at unjustifiably high prices. The profits of the early junk bond issuers Milken sponsored were around six times annual debt service, but in the late 1980s, they were often less than debt service. A Harvard Business School study found that ratings on junk bonds had fallen sharply since the early 1980s, those with the lowest rating tripling in number. Many could not meet their debt payments when the economy slowed.

The Accidental Investment Banker: Inside the Decade That Transformed Wall Street by Jonathan A. Knee

AOL-Time Warner, barriers to entry, Bear Stearns, book value, Boycotts of Israel, business logic, call centre, cognitive dissonance, commoditize, corporate governance, Corrections Corporation of America, deal flow, discounted cash flows, fear of failure, fixed income, Glass-Steagall Act, greed is good, if you build it, they will come, iterative process, junk bonds, low interest rates, market bubble, market clearing, Mary Meeker, Menlo Park, Michael Milken, new economy, Ponzi scheme, pre–internet, proprietary trading, risk/return, Ronald Reagan, shareholder value, Silicon Valley, SoftBank, technology bubble, young professional, éminence grise

But after the bankruptcy of Michael Milken’s Drexel Burnham in 1990, DLJ would emerge by the mid-1990s to take the mantle of leading junk bond house. Junk bonds are issued by companies that are too small, too young, too leveraged, or otherwise seen as too risky to attract more traditional and less expensive forms of financing. Junk bonds are defined as those that receive a rating from Moody’s or S&P that designates them as “speculative” credits as contrasted to the “investment grade” ratings earned by larger, less leveraged, more established companies. In addition to carrying a higher interest rate, junk bond issuers pay a higher “spread” to the investment bank that places the bonds, making this the most profitable part of the debt finance business.

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Although Morgan repeatedly asserted such claims were greatly exaggerated, total telecom-related losses were ultimately much greater than this. 26 Jonathan Stempel, “Morgan Stanley junk telecom bonds perform worst-analyst,” Reuters News, October 11, 2000. Salomon ultimately pulled the report at Morgan Stanley’s request. Jonathan Stempel, “Salomon pulls Morgan Stanley junk bond analysis,” Reuters News, October 13, 2000. 27 Randall Smith and Paul Sherer, “Morgan Stanley Bond Executive Resigns After Recent Management Restructuring,” Wall Street Journal, October 6, 2000. 28 Tom Barkley, “Morgan Stanley Eliminates Head Trader, Others on Junk Bond Team,” Dow Jones Business News, November 19, 2002. 29 See Pallavi Gogol, “Junk Bond Kings: MSDW’s Melchiorre A Jack of All Trades,” Dow Jones News Service, June 9, 1999. The article makes clear that for all of Anthony’s skill as a talented hybrid professional, “part investment banker, a quasi-research analyst, and a master salesman,” from a client’s perspective it is the “ ‘huge commitments of capital’” that were the real “ ‘key to a trader’s ability to function.’” 30 Pallavi Gogol, “Four Men Hold Sway Over Junk Bond World,” Wall Street Journal, June 15, 1999. 31 “Morgan Stanley Changes Parent Company Name,” Business Wire, June 18, 2002.

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In place of this ideal a culture of contingency emerged, a sense not only that each day might be your last, but that your value was linked exclusively to how much revenue was generated for the firm on that day—regardless of its source. At the height of the boom in 1999, I had recently left Goldman Sachs for Morgan Stanley. Once white-shoe Morgan was now locked in battle with relative upstart Donaldson, Lufkin and Jenrette to claim the mantle of junk bond king, up for grabs since the final implosion of Michael Milken’s Drexel Lambert in 1990. The popularization of junk bonds by Drexel had made the debt markets available to all manner of highly leveraged speculative companies—companies, in short, that were the antithesis of Morgan Stanley’s once-pristine client list. Morgan’s primary weapon in this war was its willingness to sponsor debt for “emerging” telecom companies that required huge capital investments.

Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", "there is no alternative" (TINA), "World Economic Forum" Davos, affirmative action, Alan Greenspan, Albert Einstein, algorithmic trading, Andy Kessler, AOL-Time Warner, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, book value, Bretton Woods, BRICs, British Empire, business cycle, buy the rumour, sell the news, capital asset pricing model, carbon credits, Carl Icahn, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, Daniel Kahneman / Amos Tversky, deal flow, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Dr. Strangelove, Dutch auction, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Fall of the Berlin Wall, financial engineering, financial independence, financial innovation, financial thriller, fixed income, foreign exchange controls, full employment, Glass-Steagall Act, global reserve currency, Goldman Sachs: Vampire Squid, Goodhart's law, Gordon Gekko, greed is good, Greenspan put, happiness index / gross national happiness, haute cuisine, Herman Kahn, high net worth, Hyman Minsky, index fund, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", job automation, Johann Wolfgang von Goethe, John Bogle, John Meriwether, joint-stock company, Jones Act, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, market bubble, market fundamentalism, Market Wizards by Jack D. Schwager, Marshall McLuhan, Martin Wolf, mega-rich, merger arbitrage, Michael Milken, Mikhail Gorbachev, Milgram experiment, military-industrial complex, Minsky moment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, National Debt Clock, negative equity, NetJets, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, Phillips curve, planned obsolescence, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, proprietary trading, public intellectual, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, Reminiscences of a Stock Operator, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Thaler, Right to Buy, risk free rate, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, Satyajit Das, savings glut, shareholder value, Sharpe ratio, short selling, short squeeze, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, stock buybacks, survivorship bias, tail risk, Teledyne, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, the new new thing, The Predators' Ball, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, two and twenty, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond, zero-sum game

Buyers of insurance products and policies were inadvertently purchasing junk bonds. Repackaged as guaranteed investment contracts (GICs), issued by First Executive, junk bonds were being sold to pension funds. Depositors in S&Ls and the taxpayers guaranteeing the deposits were unwittingly exposed to junk bonds. Competitive pressures meant that the debate was not about buying junk bonds but why you weren’t buying them. Milken’s Mobsters But there just wasn’t enough Chinese paper to match investor demand—there were far too few fallen angels. When Goldman Sachs and Lehman Brothers issued the first junk bonds in 1977, Milken and Drexel seized the opportunity, starting with a $30 million issue for Texas International.

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No distinction was drawn between bonds issued by investment grade companies whose ratings had fallen and issuers who started as junk.25 In the late 1980s, as the LBO boom was ending, new research studies on junk bonds corrected the problems of previous studies. Paul Asquith, a professor at Harvard Graduate School of Business, with his colleagues David Mullins and Eric Wolf, found that junk bond default rates were higher than previously stated. Around 30 percent of all junk bonds issued in 1977–9 had defaulted or been subject to a distressed exchange. Lipper Analytical Services, an investment firm, found that over 10 years junk bonds provided lower returns than government bonds, earning the same as money market funds.

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He was “the most important financier of the century.”46 In its August 1985 article, Forbes considered that Milken “isn’t just a step ahead of his Wall Street peers—he’s a quantum leap ahead, acting as venture capitalist, investment banker, trader, investor.”47 Milken’s activities entailed inherent conflicts of interest. Clients were encouraged to overfund—raise more money than required—with the surplus funds being invested in junk bonds sold by Drexel. The firm financed insurance companies and the purchase of S&Ls that then invested in junk bonds. Drexel financed acquisitions with junk bonds placed with Milken’s clients. After completion of LBOs, the company’s pension fund purchased high-yielding GICs from First Executive, creating demand for junk bonds. The higher return allowed the pension fund to reduce required contributions from the sponsor or even allow any overfunding to be returned.

King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone by David Carey

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, asset allocation, banking crisis, Bear Stearns, Bonfire of the Vanities, business cycle, Carl Icahn, carried interest, collateralized debt obligation, corporate governance, corporate raider, credit crunch, deal flow, diversification, diversified portfolio, financial engineering, fixed income, Future Shock, Gordon Gekko, independent contractor, junk bonds, low interest rates, margin call, Menlo Park, Michael Milken, mortgage debt, new economy, Northern Rock, risk tolerance, Rod Stewart played at Stephen Schwarzman birthday party, Sand Hill Road, Savings and loan crisis, sealed-bid auction, Silicon Valley, sovereign wealth fund, Teledyne, The Predators' Ball, éminence grise

Together these trends ensured a steady diet of acquisition targets for the buyout firms. But it was the advent of a new kind of financing that would have the most profound effect on the buyout business. Junk bonds, and Drexel Burnham Lambert, the upstart investment bank that single-handedly invented them and then pitched them as a means to finance takeovers, would soon provide undreamed-of amounts of new debt for buyout firms. Drexel’s ability to sell junk bonds also sustained the corporate raiders, a rowdy new cast of takeover artists whose bullying tactics shook loose subsidiaries and frequently drove whole companies into the arms of buyout firms.

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True or not, the image of LBO artists as a pernicious force on the corporate landscape was being permanently etched. Egged on by the corporate establishment and labor unions, Congress explored ways to combat hostile takeovers and junk bonds. In a series of hearings from 1987 to 1989, buyout industry executives, corporate moguls, and others trooped to Capitol Hill to defend or deride the takeover wave. There was serious talk of abolishing the tax deductibility of the interest costs on junk bonds in order to kill off the alleged menace. At a meeting with Kravis and Roberts in 1988, Senator Lloyd Bentsen, who later that year ran unsuccessfully as the Democratic nominee for vice president, was said to have tossed a study prepared by KKR about the impact of LBOs in the trash.

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Apart from the tactics and the pursuit of companies that didn’t want to be bought, junk bonds stirred controversy for another reason: Many feared that Drexel and the LBO firms were piling too much debt on too many companies, putting them at risk in an economic downturn. Though he had made his name and fortune in LBOs, Ted Forstmann became a vocal critic of junk financing. The fiery-tempered Forstmann’s dislike of Kravis by the late 1980s had ripened into a deep-seated loathing. In op-ed pieces and in interviews, Forstmann fulminated about a culture of unbridled excess and a mounting dependency on junk bonds, arguing that it was ruining the LBO business and threatened to destabilize the broader economy.

Palace Coup: The Billionaire Brawl Over the Bankrupt Caesars Gaming Empire by Sujeet Indap, Max Frumes

Airbnb, Bear Stearns, Blythe Masters, book value, business cycle, Carl Icahn, coronavirus, corporate governance, corporate raider, Credit Default Swap, data science, deal flow, Donald Trump, family office, fear of failure, financial engineering, fixed income, Jeffrey Epstein, junk bonds, lockdown, low interest rates, Michael Milken, mortgage debt, NetJets, power law, ride hailing / ride sharing, Right to Buy, Robert Solow, Savings and loan crisis, shareholder value, super pumped, Travis Kalanick

Milken’s genius as a junk-bond banker and trader was to find both companies who needed capital while also cultivating a coterie of buyers for those bonds who would show up repeatedly to stuff their balance sheets with the risky, high-yield paper. And no buyer of Drexel offerings was as loyal as Fred Carr, who ran a California-based life insurance and annuities firm called Executive Life. Connie Bruck reported in the Predator’s Ball that by 1983, Executive Life had participated as a buyer in 100 percent of Drexel junk bond offerings. Executive Life eventually held billions worth of junk bonds, using the yields to pay high returns to its policyholders.

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Howard Marks, the co-founder of Oaktree, was never a Drexel employee. But as a consistent buyer of Drexel junk bonds in the 1980s while an investment manager at Citigroup, he eventually became like family to Leon Black. And their wives, Nancy Marks and Debra Black, would become especially close. In 1978, after years as an equity analyst at Citigroup, the bank asked Marks to look into the nascent junk bond market that Michael Milken was creating in Los Angeles. Marks eventually moved to LA in the late 1970s to start up within Citigroup what was thought to be the first institutional junk bond fund. In 1985, Marks jumped to Trust Company of the West, also in Los Angeles, one of the largest fixed income investors in the world.

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The high-flying investment bank had dominated Wall Street in the 1980s with its mastery of the junk bond, a previously misunderstood form of financing for riskier—or more marginalized—companies. But Drexel’s wild ride of the previous decade had ended with an abrupt thud. On February 13, Drexel filed for Chapter 11 bankruptcy protection after pleading guilty to six counts of securities and mail fraud a year earlier—the fallout of the sprawling and spectacular white-collar crime spree masterminded by its larger-than-life banker, the so-called “junk bond king,” Michael Milken. Milken himself was facing ninety-eight counts of insider trading, securities fraud, and racketeering related to accusations of massive self-dealing while running the Drexel junk bond unit.

Sabotage: The Financial System's Nasty Business by Anastasia Nesvetailova, Ronen Palan

Alan Greenspan, algorithmic trading, bank run, banking crisis, barriers to entry, Basel III, Bear Stearns, Bernie Sanders, big-box store, bitcoin, Black-Scholes formula, blockchain, Blythe Masters, bonus culture, Bretton Woods, business process, collateralized debt obligation, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, critique of consumerism, cryptocurrency, currency risk, democratizing finance, digital capitalism, distributed ledger, diversification, Double Irish / Dutch Sandwich, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, financial intermediation, financial repression, fixed income, gig economy, Glass-Steagall Act, global macro, Gordon Gekko, high net worth, Hyman Minsky, independent contractor, information asymmetry, initial coin offering, interest rate derivative, interest rate swap, Joseph Schumpeter, junk bonds, Kenneth Arrow, litecoin, London Interbank Offered Rate, London Whale, Long Term Capital Management, margin call, market fundamentalism, Michael Milken, mortgage debt, new economy, Northern Rock, offshore financial centre, Paul Samuelson, peer-to-peer lending, plutocrats, Ponzi scheme, Post-Keynesian economics, price mechanism, regulatory arbitrage, rent-seeking, reserve currency, Ross Ulbricht, shareholder value, short selling, smart contracts, sovereign wealth fund, Thorstein Veblen, too big to fail

But Milken was not content to restrict himself to fallen angels. Soon he expanded and began to use junk bonds to finance leveraged buyouts of companies. ‘Leveraged buyouts’ (LBOs) is a polite term for corporate raiding. Junk bonds were used to finance the hugely ambitious corporate raiders and private equity firms.5 Through junk bond leverage buyouts, companies with poor ratings could acquire better-performing companies. In the deal the acquiring company would use the target companies’ funds to repay the debt it incurred to fund the takeover in the first place – ideally to Milken’s bank. Junk bonds became the weapon of choice of hostile raiders churning up and destroying companies in the process.

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‘Stars of the Junkyard’, Economist, 21 October 2010, www.economist.com/briefing/2010/10/21/stars-of-the-junkyard. 5. W. Cohan, ‘Michael Milken invented the modern junk bond, went to prison, and then became one of the most respected people on Wall Street’, Business Insider, 2 May 2017, http://uk.businessinsider.com/michael-milken-life-story-2017-5?r=US&IR=T. 6. ‘Stars of the Junkyard’, Economist. 7. Cohan, ‘Michael Milken invented the modern junk bond’. 8. ‘Stars of the Junkyard’, Economist. 9. Cohan, ‘Michael Milken invented the modern junk bond’. 10. Insights for this section come from the best story written about the role of Ranieri personally and Salomon Brothers as an institution: Michael Lewis’s Liar’s Poker: Two Cities, True Greed, Hodder and Stoughton, 1989. 11.

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Only we would add that if we have learned anything in the past four decades, it is that financial innovation includes the sabotage not only of governments but also of clients and competitors. It is this unique ability to combine all three of the qualities John Tuld lists to his board that seems to ensure really big money. THE KING OF JUNK In the early 1980s a certain Michael Milken invented what became known as the ‘junk bond’; or, more elegantly, the high-yield bond. Junk bonds are considered among the most important innovations in twentieth-century finance. Their creator, Michael Milken, would be widely celebrated by the industry. Eventually Milken’s efforts would afford him residency of an exclusive gated community in California, better known as the Bay Area Prison.

Manias, Panics and Crashes: A History of Financial Crises, Sixth Edition by Kindleberger, Charles P., Robert Z., Aliber

active measures, Alan Greenspan, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, Black Swan, Boeing 747, Bonfire of the Vanities, break the buck, Bretton Woods, British Empire, business cycle, buy and hold, Carmen Reinhart, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, Corn Laws, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cross-border payments, currency peg, currency risk, death of newspapers, debt deflation, Deng Xiaoping, disintermediation, diversification, diversified portfolio, edge city, financial deregulation, financial innovation, Financial Instability Hypothesis, financial repression, fixed income, floating exchange rates, George Akerlof, German hyperinflation, Glass-Steagall Act, Herman Kahn, Honoré de Balzac, Hyman Minsky, index fund, inflation targeting, information asymmetry, invisible hand, Isaac Newton, Japanese asset price bubble, joint-stock company, junk bonds, large denomination, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low interest rates, margin call, market bubble, Mary Meeker, Michael Milken, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, new economy, Nick Leeson, Northern Rock, offshore financial centre, Ponzi scheme, price stability, railway mania, Richard Thaler, riskless arbitrage, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, special drawing rights, Suez canal 1869, telemarketer, The Chicago School, the market place, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, very high income, Washington Consensus, Y2K, Yogi Berra, Yom Kippur War

In a Cassandra-like book, Henry Kaufman decried the increase of all kinds of debt – consumer, government, mortgage, and corporate, including junk bonds; Kaufman argued that the quality of debt declined as the quantity of debt increased.20 Felix Rohatyn, a distinguished investment banker and the head of the US office of Lazard Frères, called the United States ‘a junk-bond casino’. Still, the owners of junk bonds were earning much higher interest rates than the owners of traditional bonds – at least for a while. In the economic slowdown of the late 1980s and early 1990s, many of the firms that had issued junk bonds went bankrupt. A new set of studies showed that the owners of junk bonds on average lost one-third of their money and that the additional three to four percentage points of interest income per year of these bonds was insufficient to compensate for the losses on the defaulted bonds.

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Many of the firms were unable to earn enough to pay the interest on the outstanding junk bonds. Not to worry, these firms issued some new securities that relieved them of the obligation to pay the interest on their outstanding bonds and the Milken-friendly thrifts bought these securities too. The money machine continued to work as long as the junk bond market remained vibrant. (Is this reminiscent of Ponzi finance?) However, the junk bond market collapsed at the end of the 1980s, after Federal regulators changed the rules so that the thrifts could no longer buy these bonds. The liquidity disappeared from the junk bond market; the prices of these bonds declined sharply, and the bondholders incurred large losses.

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During economic slowdowns, many firms experience less rapid increases in their revenues than they had anticipated with the result that some that had been in the hedge finance group are shunted into the speculative finance group while some firms that had been in the speculative finance group move into the Ponzi finance group. Drexel Burnham Lambert, Michael Milken, and ‘junk bonds’ One of the great financial innovations in the 1980s was the development of ‘junk bonds’ – the bonds of firms that had not been ranked by one of the major credit-rating agencies. The interest rates on these bonds were generally three to four percentage points higher than interest rates on the bonds that had been ranked in one of the ‘investment grades’. Many of the junk bonds had been ‘fallen angels’ – issued by firms when their economic circumstances were more favorable so they received a credit rating.

King Icahn: The Biography of a Renegade Capitalist by Mark Stevens

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", Bear Stearns, book value, Carl Icahn, classic study, company town, corporate governance, corporate raider, Donald Trump, financial engineering, flag carrier, Gordon Gekko, Irwin Jacobs, junk bonds, laissez-faire capitalism, low interest rates, Michael Milken, old-boy network, Ponzi scheme, profit motive, shareholder value, yellow journalism

Based on this finding—which he supported with prodigious research of his own—Milken set out to change the investment community’s perception of “junk bonds” from virtual untouchables to instruments of choice. Blessed with an idea whose time had come, a brilliant financial mind and an instinctive gift for salesmanship, Milken built a powerful network of supporters (wealthy individuals and corporations) who were eager to avail themselves of the junk bonds’ higher yields. Similar to Icahn’s early work in options, Milken created a market in which junk bonds were bought and sold through his increasingly successful Drexel Burnham trading operation (which he relocated from New York to Century City, California, in 1978 and ultimately moved to Beverly Hills).

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Drexel’s plan would be a momentous step, launching, in a decade already known for the megadeal, the daddy of all hostile tenders, requiring a staggering $8 billion. Could it be done? DLJ was very skeptical. But Drexel had Mike Milken and Milken had his junk bond network and although he had never raised anything close to $8 billion, Milken was confident. Behind the scenes, an interesting component of Icahn/Drexel strategy unfolded. Rather than seeking commitments from its junk bond buyers in anticipation of the deal—thus requiring him to pay substantial fees up front—Icahn suggested that Drexel simply provide him with a commitment letter of its own. From Icahn’s perspective, there was little risk to Drexel, which was certain it could raise the money.

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“We felt just as the letter said, ‘highly confident’ that we could raise the money,” says the former Drexel executive. “When Mike Milken said we could do it, we believed it. We figured, ‘What does Morgan Stanley know about junk bonds?’ We were the only guys on Wall Street who knew how to use them.” After Phillips took out newspaper ads portraying Icahn as a paper tiger, Carl agreed to pay Drexel $7.5 million in fees to go beyond the “highly confident” letter and to secure commitments from Milken’s junk bond buyers. The way the deal was structured, Icahn would have to pay the investors 3/8 of 1 percent of the money they pledged if the deal went through, 1/8 of 1 percent if the deal fell apart after the funds were pledged.

Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen

asset allocation, asset-backed security, Benchmark Capital, book value, buy and hold, capital controls, classic study, cognitive dissonance, corporate governance, deal flow, diversification, diversified portfolio, equity risk premium, financial engineering, fixed income, index fund, junk bonds, law of one price, Long Term Capital Management, low interest rates, market bubble, market clearing, market fundamentalism, money market fund, passive investing, Paul Samuelson, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Savings and loan crisis, shareholder value, Silicon Valley, Steve Ballmer, stocks for the long run, survivorship bias, technology bubble, the market place, transaction costs, Vanguard fund, yield curve, zero-sum game

Moving down the ratings rungs, single-B bonds “lack characteristics of the desirable investment,” triple-C bonds “are of poor standing,” double-C bonds “are speculative in high degree,” and the lowest class of bonds (single-C) have “extremely poor prospects of ever attaining any real investment standing.”6 High-yield bonds suffer from a concentrated version of the unattractive traits of high-grade corporate debt. Credit risk in the junk-bond market far exceeds risk levels in the investment-grade market. Illiquidity abounds, with the lowest-rated credits trading by appointment only. Callability poses the familiar “heads you win, tails I lose” proposition for owners of junk bonds, with an added twist. Holders of both investment-grade and junk bonds face callability concerns in declining-rate environments. Lower rates prompt refunding calls in which the issuer pays a fixed price to the bondholders and reissues debt at lower cost. Holders of high-quality paper and junk bonds face interest-rate-induced refunding risks of similar nature.

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In spite of the dampening effect of the PCA 9.625s’ call provision, bondholders received handsome holding-period returns. Buoyed by improving credit fundamentals and declining interest rates, the junk-bond investors garnered a return of 49.2 percent from January 28, 2000, the date of the company’s IPO, to July 21, 2003, the date of the completion of the tender offer. Junk-bond investors could not hope for better circumstances or better results. How did the PCA junk bond returns compare to results from closely related alternative investments? Strikingly, a comparable-maturity U.S. Treasury note produced a holding period return of 45.8 percent, as the noncallable nature of the government issue allowed investors to benefit fully from the bond market rally.

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Recall that the PCA 9.625s of April 2009 entered the markets in 1999 at the bottom of the single-B rating category, precariously positioned with a “small assurance of maintenance of contract terms.” Credit deterioration would likely damage the investments of bondholders and stockholders alike. Junk-bond investors cannot win. When fundamentals improve, stock returns dominate bond returns. When rates decline, noncallable bonds provide superior risk-adjusted returns. When fundamentals deteriorate, junk-bond investors fall along with equity investors. Well-informed investors avoid the no-win consequences of high-yield fixed-income investing. Alignment of Interests Junk-bond owners face misalignment of interest problems even more severe than those faced by investment-grade bondholders.

Rigged Money: Beating Wall Street at Its Own Game by Lee Munson

affirmative action, Alan Greenspan, asset allocation, backtesting, barriers to entry, Bear Stearns, Bernie Madoff, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fear index, fiat currency, financial engineering, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, Glass-Steagall Act, global macro, High speed trading, housing crisis, index fund, joint-stock company, junk bonds, managed futures, Market Wizards by Jack D. Schwager, Michael Milken, military-industrial complex, money market fund, moral hazard, Myron Scholes, National best bid and offer, off-the-grid, passive investing, Ponzi scheme, power law, price discovery process, proprietary trading, random walk, Reminiscences of a Stock Operator, risk tolerance, risk-adjusted returns, risk/return, Savings and loan crisis, short squeeze, stocks for the long run, stocks for the long term, too big to fail, trade route, Vanguard fund, walking around money

Simply stated, they are bonds with a poor rating. Most notably, junk bonds have higher credit risk and illiquidity, but also higher interest payments—as long as they keep paying. I want to cover the problem with junk bonds within a portfolio, the true cost of owning them, and how investors should approach the junk bond market. As a warning, most investors should simply stay away. That doesn’t mean they don’t have a place, but like many niche markets the application is small compared to the herd of stockbrokers touting them. There is something to be said about junk bonds and those that invest in them. Often my firm encounters clients and potential clients that ask if we invest in junk bonds.

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To add injury to insult, some parts of the market, even well-known areas like junk bonds, can fail to translate into a successful ETF. SPDR Barclays Capital High Yield Bond ETF (JNK) may be the worst bond strategy of all time. Now that I have your attention, let’s break down the major issues with junk bonds, and more specifically ETFs that trade baskets of those bonds. Don’t worry, there is a place for these ugly ducklings, but they are not for those trying to get fixed income risk and return. If that doesn’t keep you reading, nothing will. The junk bond market developed by Michael Milken in the 1980s is predominately a U.S. phenomenon, though they exist anywhere there is tradable debt.

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Often my firm encounters clients and potential clients that ask if we invest in junk bonds. My first reaction is to question why they are interested. Usually investors see high yields as a magic bullet providing return and no risk. After all, it’s a bond, right? Some clients are savvy enough to see it as a potential play on improving credit risk, which can lead to capital appreciation if properly timed. Unfortunately, not all ugly ducklings will turn into beautiful swans. The best opportunities involve the worst of the worst junk bonds, are illiquid, and end up as the hunting ground of the best hedge fund managers in the world.

The Essays of Warren Buffett: Lessons for Corporate America by Warren E. Buffett, Lawrence A. Cunningham

book value, business logic, buy and hold, compensation consultant, compound rate of return, corporate governance, Dissolution of the Soviet Union, diversified portfolio, dividend-yielding stocks, fixed income, George Santayana, Henry Singleton, index fund, intangible asset, invisible hand, junk bonds, large denomination, low cost airline, Michael Milken, oil shock, passive investing, price stability, Ronald Reagan, stock buybacks, Tax Reform Act of 1986, Teledyne, the market place, transaction costs, Yogi Berra, zero-coupon bond

Wall Street cared little for such distinctions. As usual, the Street's enthusiasm for an idea was proportional not to its merit, but rather to the revenue it would produce. Mountains of junk bonds were sold by those who didn't care to those who didn't think-and there was no shortage of either. Junk bonds remain a mine field, even at prices that today are often a small fraction of issue price. As we said last year, we have never bought a new issue of a junk bond. (The only time to buy these is on a day with no "y" in it.) We are, however, willing to look at the field, now that it is in disarray. In the case of RJR Nabisco, we feel the Company's credit is considerably better than was generally perceived for a while and that the yield we receive, as well as the potential for capital gain, more than compensates for the risk we incur (though that is far from nil).

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Challenging both Wall Street and the academy, Buffett again draws on Graham's ideas to reject the "dagger thesis" advanced to defend junk bonds. The dagger thesis, using the metaphor of the intensified care an automobile driver would take facing a dagger mounted on the steering wheel, overemphasizes the disciplining effect that enormous amounts of debt in a capital structure exerts on management. Buffett points to the large numbers of corporations that failed in the early 1990s recession under crushing debt burdens to dispute academic research showing that higher interest rates on junk bonds more than compensated for their higher default rates. He attributes this error to a flawed assumption recognizable to any first-year statistics student: that historical conditions prevalent during the study period would be identical in the future.

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In the past we have bought a few below-investment-grade bonds with success, though these were all old-fashioned "fallen angels"-bonds that were initially of investment grade but that were downgraded when the issuers fell on bad times. . . . A kind of bastardized fallen angel burst onto the investment scene in the 1980s-"junk bonds" that were far below investmentgrade when issued. As the decade progressed, new offerings of manufactured junk became ever junkier and ultimately the predictable outcome occurred: Junk bonds lived up to their name. In 1990-even before the recession dealt its blows-the financial sky became dark with the bodies of failing corporations. The disciples of debt assured us that this collapse wouldn't happen: Huge debt, we were told, would cause operating managers to focus their efforts as never before, much as a dagger mounted on the steering wheel of a car could be expected to make its driver proceed with intensified care.

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

Albert Einstein, asset allocation, asset-backed security, book value, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, clean water, collateralized debt obligation, computerized markets, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, equity risk premium, fear index, financial engineering, fixed income, Glass-Steagall Act, implied volatility, index fund, intangible asset, interest rate swap, inventory management, inverted yield curve, junk bonds, London Interbank Offered Rate, low interest rates, margin call, money market fund, mortgage debt, Myron Scholes, passive investing, performance metric, risk free rate, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, short squeeze, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

Only after preferred shareholders have been paid back are the remaining assets (if any) divided among common shareholders. Related Terms: • Bankruptcy • Common Stock • Subordinated Debt • Bond • Preferred Stock The Investopedia Guide to Wall Speak 151 Junk Bond What Does Junk Bond Mean? A bond rated BB or lower because of its high risk of default. Also known as a high-yield bond or speculative bond. This type of bond is considered less than investment grade. Investopedia explains Junk Bond These bonds usually are purchased for speculative purposes. Junk bonds typically offer interest rates three to four percentage points higher than those on safer government issues. The higher interest rate is meant to compensate investors for the higher risks associated with the issuer.

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Here’s how the Standard & Poor’s rating system works: AAA and AA: high credit-quality investment grade; AA and BBB: medium credit-quality investment grade; BB, B, CCC, CC, and C: low creditquality (noninvestment grade), or “junk bonds”; D: bonds in default for nonpayment of principal and/or interest. The Investopedia Guide to Wall Speak 27 Related Terms: • Credit Rating • Interest Rate • Junk Bond • High-Yield Bond • Investment Grade Book Value What Does Book Value Mean? (1) The value at which an asset is carried on a balance sheet; in other words, the cost of an asset minus accumulated depreciation. (2) The net asset value of a company, calculated as total assets minus intangible assets (patents, goodwill) and liabilities. (3) The initial outlay for an investment.

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Bonds with ratings above these levels are considered investment-grade. Credit ratings can be as low as D (currently in default), and most bonds with C ratings or lower carry a high risk of default; to compensate for this risk, yields typically are very high. Also known as junk bonds. Investopedia explains High-Yield Bond The term “junk bonds” aside, high-yield bonds are widely held by investors worldwide, although most participate through the use of mutual funds or exchange-traded funds. The yield spread between investment-grade and high-yield bonds fluctuates over time, depending on the state of the economy, as well as company- and sector-specific events.

Buffett by Roger Lowenstein

Alan Greenspan, asset allocation, Bear Stearns, book value, Bretton Woods, buy and hold, Carl Icahn, cashless society, collective bargaining, computerized trading, corporate raider, credit crunch, cuban missile crisis, Eugene Fama: efficient market hypothesis, index card, index fund, interest rate derivative, invisible hand, Jeffrey Epstein, John Meriwether, junk bonds, Long Term Capital Management, Michael Milken, moral hazard, Paul Samuelson, random walk, risk tolerance, Robert Shiller, Ronald Reagan, Savings and loan crisis, selection bias, Teledyne, The Predators' Ball, traveling salesman, Works Progress Administration, Yogi Berra, young professional, zero-coupon bond

And Wall Street’s soaring appetite for junk bonds was providing a vast supply of easy money. Junk bonds had become a kind of “phony currency” (phony because bond buyers were thoughtlessly, and naïvely, financing borrowers beyond their means). Whoever could borrow the most was winding up with the store. To Buffett, this was truly vexing. The trouble with debt was that it worked too well; people got hooked and carried it too far. And he allowed that the new borrowers would repeat this pattern. “I personally think, before it’s all over, junk bonds will live up to their name.” For 1985, this was strong talk. Junk bonds were thriving, and defaults had been rare.

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Bankrupt credits often were attractive on a price-to-value basis; Michael Milken, Drexel’s junk-bond impresario, had gotten his start trading just such “fallen angels.” Junk bonds of recent vintage had the crucial distinction of not having yet fallen: they were weak credits issued at par (full price), with a long way to fall and little upside. Buffett, continuing in his “pejorative” vein, pointed out that the issuers of those junk bonds were raking in very fat fees, as were the deal promoters. To him, the takeover game resembled an addiction, and Wall Street was pushing junk-bond “needles” to keep the Street in a stupor. “It won’t die out without a big bang,” Buffett predicted.

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Indeed, Buffett was a master dissimulator. At the very moment that his junk-bond critique was rolling off the press, Buffett was scooping up one of the largest bundles of junk bonds ever—$440 million of RJR Nabisco paper. RJR Nabisco’s bonds had collapsed with the general market, but in Buffett’s view, the market had overreacted. (After all, RJR Nabisco was still selling a high-margin product to “addicts.”) His purchase of junk bonds might seem hypocritical, but it was not. Buffett saw a moral hazard in selling a junk bond that would likely never be repaid. Buying a bond was different. To the investor, no financial instrument was “evil per se”;38 it was a question of price.

Panderer to Power by Frederick Sheehan

Alan Greenspan, Asian financial crisis, asset-backed security, bank run, banking crisis, Bear Stearns, book value, Bretton Woods, British Empire, business cycle, buy and hold, California energy crisis, call centre, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversification, financial deregulation, financial innovation, full employment, Glass-Steagall Act, Greenspan put, guns versus butter model, inflation targeting, interest rate swap, inventory management, Isaac Newton, John Meriwether, junk bonds, low interest rates, margin call, market bubble, Mary Meeker, McMansion, Menlo Park, Michael Milken, money market fund, mortgage debt, Myron Scholes, new economy, Nixon triggered the end of the Bretton Woods system, Norman Mailer, Northern Rock, oil shock, Paul Samuelson, place-making, Ponzi scheme, price stability, reserve currency, rising living standards, Robert Solow, rolodex, Ronald Reagan, Sand Hill Road, Savings and loan crisis, savings glut, shareholder value, Silicon Valley, Silicon Valley startup, South Sea Bubble, stock buybacks, stocks for the long run, supply-chain management, supply-chain management software, The Great Moderation, too big to fail, transaction costs, trickle-down economics, VA Linux, Y2K, Yom Kippur War, zero-sum game

Commercial bank entry broadened the residential mortgage market; the growing junkbond appetite of savings and loans, insurance companies, and mutual funds extended the ability of investment banks to underwrite more junk bonds. 26 Wigmore, Securities Markets in the 1980s, pp. 50–51. 27 Ibid. Michael Milken’s group at the investment-banking house of Drexel Burnham (later to be Drexel Burnham Lambert Inc.) educated the world, and then dominated it, in the fertile laboratory of junk bonds.29 (Junk bonds are those that are rated below investment grade by the rating agencies.) Early buyers of Drexel’s junk bonds had acquired valuable experience in the conglomerate years—Carl Lindner of American Financial Corporation and Saul Steinberg of Reliance Insurance.30 After his initial success with “fallen angels”—companies that had fallen on hard times and been downgraded—Milken gravitated toward “new-issue” junk bonds.

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Barrie Wigmore, author of a seminal financial study of the period, found that this was one development he could not quantify: “How much the surge in junk bond new-issues in 1983 and 1984 was due to expanded savings and loan powers and the merger boom and how dependent it was on under-the-table incentives to money managers will probably never be resolved.”34 28 Ibid., p. 303. 29 Ibid. 30 Ibid., p. 280. Milken did not invent junk bonds, as is often claimed. There were precedents: railroad and REIT (real estate investment trust) junk bonds. 31 Ibid., p. 282. 32 Ibid., p. 283. 33Ibid. p. 282. Between 1980 and 1982 the ratio of earnings before interest and taxes (EBIT) divided by debt payments was about 2.0.

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Early buyers of Drexel’s junk bonds had acquired valuable experience in the conglomerate years—Carl Lindner of American Financial Corporation and Saul Steinberg of Reliance Insurance.30 After his initial success with “fallen angels”—companies that had fallen on hard times and been downgraded—Milken gravitated toward “new-issue” junk bonds. Drexel performed an admirable service by finding investors for some promising companies, with Turner Broadcasting and Humana being early success stories.31 It was not long before the weapon (junk bonds) and the strategy (hostile bids) discovered each other. One other component was needed: a willing buyer. The mutual fund industry offered 11 junkbond funds before 1980.32 The early financings were responsibly packaged to permit the companies so structured to cover their debt payments out of projected earnings.

The Gone Fishin' Portfolio: Get Wise, Get Wealthy...and Get on With Your Life by Alexander Green

Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, backtesting, behavioural economics, borderless world, buy and hold, buy low sell high, cognitive dissonance, diversification, diversified portfolio, Elliott wave, endowment effect, Everybody Ought to Be Rich, financial independence, fixed income, framing effect, hedonic treadmill, high net worth, hindsight bias, impulse control, index fund, interest rate swap, Johann Wolfgang von Goethe, John Bogle, junk bonds, Long Term Capital Management, means of production, mental accounting, Michael Milken, money market fund, Paul Samuelson, Ponzi scheme, risk tolerance, risk-adjusted returns, short selling, statistical model, stocks for the long run, sunk-cost fallacy, transaction costs, Vanguard fund, yield curve

A corporate bond is a company’s IOU, a debt security that represents a promise to repay a sum of money at a fixed interest rate over a certain period of time. Short-term bonds generally yield somewhat less than long-term bonds. (Although when the yield curve is inverted, they may yield more.) Their shorter maturities make them less volatile than long-term bonds. 9. High-yield bonds. High yield or “junk bonds” are corporate bonds that do not qualify for investment-grade ratings. These bonds pay higher rates of interest because the issuers are less creditworthy. Default rates are higher than on investment-grade bonds as well. (According to Moody’s, the annual default rate for BB/Ba bonds is about 1.5%.) 10.

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High-yield bonds, also called non- investment-grade bonds, are also corporate bonds. These are bonds rated BBB- or lower by the rating agency Standard & Poor’s. They are issued by companies less creditworthy than those that issue investment-grade bonds and are considered speculative. But don’t let the name junk bond throw you. A diversified portfolio of these bonds, even after accounting for defaults, has returned more than either Treasuries or high-grade corporates. And while they do tend to be more highly correlated with the stock market than other bonds, they do not move in lock step with equities, giving you some diversification advantage. 3.

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Rather, it’s to allow you to achieve financial independence and its most important by-product: peace of mind. WHAT TO TELL THE NAYSAYERS There are some aspects of the Gone Fishin’ strategy that critics—and fee-oriented investment advisors—may find controversial. I want to address those potential objections now. Some, for example, may object to the inclusion of asset classes like gold shares and junk bonds. Others will question the weightings of different asset classes. Still others will question the “one-size-fits-all” nature of this strategy. I’m happy to rebut them all. Unusual Success from Unusual Assets Let’s begin by looking at the reasons for the inclusion of more controversial asset classes like gold shares, foreign stocks (particularly emerging market stocks), and high-yield bonds.

The Permanent Portfolio by Craig Rowland, J. M. Lawson

Alan Greenspan, Andrei Shleifer, asset allocation, automated trading system, backtesting, bank run, banking crisis, Bear Stearns, Bernie Madoff, buy and hold, capital controls, correlation does not imply causation, Credit Default Swap, currency risk, diversification, diversified portfolio, en.wikipedia.org, fixed income, Flash crash, high net worth, High speed trading, index fund, inflation targeting, junk bonds, low interest rates, margin call, market bubble, money market fund, new economy, passive investing, Ponzi scheme, prediction markets, risk tolerance, stocks for the long run, survivorship bias, technology bubble, transaction costs, Vanguard fund

If you need your bonds to protect you during an economic crisis you don't want them to be subject to credit or default risk, but that's exactly what junk bonds give you—in spades. In a sense, they are one of the worst investments you can own—you get all of the volatility and risk of stocks but little of the upside potential. Junk bonds can also generate very poor tax treatment if not held in a tax-deferred account as they are taxed at all levels. During 2008 in the midst of the financial crisis, many junk bond funds lost 30 percent or more in value. Figure 7.3 shows the performance of junk bonds versus long-term U.S. Treasury bonds. Figure 7.3 2008 Performance of Long-Term U.S. Treasury Bonds versus Junk Bonds.U.S. Treasury bonds were up over 30 percent and junk bonds sunk by 30 percent providing no diversification benefit and compounding losses.

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The 2008 to early 2009 period covered in Figure 5.2 shows the performance for the Total Bond Market, Corporate Bond Index, High-Yield (Junk) Bonds, and the popular American Century International Bond Fund during the market crash. Figure 5.2 In 2008 and Early 2009 Low-Quality Bonds Exhibited Stock-Like Losses.Other bonds did not move enough to offer solid diversification. Chart courtesy of stockcharts.com. At the bottom of the 2008 crash high-yield junk bonds and corporate bonds suffered losses of 30 percent and 20 percent, respectively. The other funds slightly lagged or remained relatively flat during this period.

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Investors who opt for this approach should realize that they are sacrificing deflation protection by making the decision to avoid U.S. Treasury bonds. A serious economic crisis could see widespread defaults in corporate bonds, including those previously considered very safe. Junk Bonds High-yield bonds (also known as junk bonds) are a type of bond with an enticingly high yield but lots of risk. Don't let the high interest rates convince you to buy them for the Permanent Portfolio, as they are totally unsuitable for this application. Bonds are for safety and not speculation. Buying higher risk bonds means you are chasing yield and it can be dangerous because higher rewards always mean higher risk.

Damsel in Distressed: My Life in the Golden Age of Hedge Funds by Dominique Mielle

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", activist fund / activist shareholder / activist investor, airline deregulation, Alan Greenspan, banking crisis, Bear Stearns, Black Monday: stock market crash in 1987, blood diamond, Boris Johnson, British Empire, call centre, capital asset pricing model, Carl Icahn, centre right, collateralized debt obligation, Cornelius Vanderbilt, coronavirus, COVID-19, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, family office, fear of failure, financial innovation, fixed income, full employment, glass ceiling, high net worth, hockey-stick growth, index fund, intangible asset, interest rate swap, John Meriwether, junk bonds, Larry Ellison, lateral thinking, Long Term Capital Management, low interest rates, managed futures, mega-rich, merger arbitrage, Michael Milken, Myron Scholes, Northpointe / Correctional Offender Management Profiling for Alternative Sanctions, offshore financial centre, Paul Samuelson, profit maximization, Reminiscences of a Stock Operator, risk free rate, risk tolerance, risk-adjusted returns, satellite internet, Savings and loan crisis, Sharpe ratio, Sheryl Sandberg, SoftBank, survivorship bias, Tesla Model S, too big to fail, tulip mania, union organizing

For one thing, whereas a stock is not a particularly interesting security per se (the underlying corporation is interesting but not the instrument), junk bonds are fascinating creations. A stock is a stock, a slice of equity, a financial construct that doesn’t change much apart from its dividend and the voting rights—a stock is, by nature, a voting share giving shareholders the crucial right to elect corporate directors and make their views known in different matters. But a corporate debt is a private contract with infinite variations. Even in a very well-established market like the U.S. leverage loan, junk bond, or investment-grade bond markets, there are meaningful divergences—sometimes very subtle, sometimes glaring—sufficient to separate a losing trade from a winning one.

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They had paid one hundred cents on the dollar and woke up after 9/11 to see it trade at eighty, sixty, forty, or twenty cents. It was garbage; it was toxic. Some funds, with strategy and risk parameters that did not permit investing in junk bonds, couldn’t hold on after the ratings downgrades. Some didn’t have the manpower or patience to sustain the labor-intensive research required in a distressed situation. They fled the sector en masse, forcefully selling at very uneconomic prices. You don’t improvise switching from trading safe, investment-grade, high-quality bonds to nonperforming junk bonds. Try asking a poet to write comics because there is a market for them. Great opportunity, wrong skill set. Traditional credit analysis was useless at this point.

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I rehashed my positions and decision process in a never-ending mental loop. I lost confidence in my ability to invest and make sound judgments on the market. And the way back up wasn’t easy. There was no market to speak of for junk bonds, leveraged loans, and most of our assets from mid-2008 to spring 2009. For financial securities that do not trade through an electronic stock exchange, like many corporate fixed income instruments including junk bonds and distressed securities, a trader must match an actual physical buyer and a seller, much like a real estate broker representing a house. If there is no willing seller or buyer—the seller is loath to sell at what he considers a ludicrously low bid and the buyer is unwilling to step up to what he believes is a preposterous ask—there is simply no trade at all.

All the Money in the World by Peter W. Bernstein

Albert Einstein, anti-communist, AOL-Time Warner, Bear Stearns, Berlin Wall, Bill Gates: Altair 8800, book value, call centre, Carl Icahn, Charles Lindbergh, clean tech, Cornelius Vanderbilt, corporate governance, corporate raider, creative destruction, currency peg, David Brooks, Donald Trump, estate planning, Fairchild Semiconductor, family office, financial engineering, financial innovation, George Gilder, high net worth, invisible hand, Irwin Jacobs: Qualcomm, Jeff Bezos, job automation, job-hopping, John Markoff, junk bonds, Larry Ellison, Long Term Capital Management, Marc Andreessen, Martin Wolf, Maui Hawaii, means of production, mega-rich, Menlo Park, Michael Milken, Mikhail Gorbachev, new economy, Norman Mailer, PageRank, Peter Singer: altruism, pez dispenser, popular electronics, Quicken Loans, Renaissance Technologies, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Sand Hill Road, school vouchers, Search for Extraterrestrial Intelligence, shareholder value, short squeeze, Silicon Valley, Silicon Valley billionaire, Silicon Valley startup, SoftBank, stem cell, Stephen Hawking, Steve Ballmer, Steve Jobs, Steve Wozniak, tech baron, tech billionaire, Teledyne, the new new thing, Thorstein Veblen, too big to fail, traveling salesman, urban planning, wealth creators, William Shockley: the traitorous eight, women in the workforce

The appeal was obvious, so long as you could stomach the risk. Junk bond yields were 3 to 5 percent above Treasury and higher-rated corporate bonds. At first Milken underwrote19 new junk bonds for companies too minor or unproven to issue investment-grade bonds,*11 such as the young telecommunications companies that were just starting to challenge AT&T’s government-backed monopoly, and entrepreneurs shunned by Wall Street, including insurance company CEO Carl Lindner, the target of an SEC investigation in Cincinnati, and Victor Posner, a conglomerator with an unsavory reputation.†12 Then, in 1984, Milken began using20 junk bonds to finance takeover bids.

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Craig began investing in cellular licenses from the outset, buying pops for as little as $6 each, at a time when the business was so new that few people were thinking about it. But as cellular grew27, so did the cost of acquiring the pops. The bill for licenses ran into hundreds of millions of dollars. Throughout the 1980s McCaw bought hundreds of thousands of pops, aided by junk bonds issued by junk-bond king Michael Milken. (See Chapter 8, Beyond Wall Street.) McCaw began by building a cellular network on the West Coast; but it soon became obvious that he needed a national network. After he sold Twin City Cablevision in 1987, McCaw was free to devote even more time to his cellular plans and to plow ever-greater sums into the acquisition of pops.

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By 1986 mergers and acquisition activity on Wall Street had hit record levels. It was a “casino society,”16 remarked investment banker Felix Rohatyn of Lazard Frères, then one of Wall Street’s celebrated private firms, with outposts in London and Paris. Another new wrinkle17—junk bonds—helped LBO returns soar, though Ted Forstmann, who claimed returns equal to or better than KKR, derided them as “wampum.” The junk bond market was promoted by a then-unknown investment banker, Michael Milken, at Drexel Burnham Lambert, a second-tier investment bank that, because of Milken, would soon outperform many of its white-shoe competitors. Milken’s key insight was that the low-grade debt of many companies with poor credit ratings was a good deal.

Why Wall Street Matters by William D. Cohan

Alan Greenspan, Apple II, asset-backed security, bank run, Bear Stearns, Bernie Sanders, Blythe Masters, bonus culture, break the buck, buttonwood tree, Carl Icahn, corporate governance, corporate raider, creative destruction, Credit Default Swap, Donald Trump, Exxon Valdez, financial innovation, financial repression, Fractional reserve banking, Glass-Steagall Act, Gordon Gekko, greed is good, income inequality, Joseph Schumpeter, junk bonds, London Interbank Offered Rate, margin call, Michael Milken, money market fund, moral hazard, Potemkin village, quantitative easing, secular stagnation, Snapchat, South Sea Bubble, Steve Jobs, Steve Wozniak, tontine, too big to fail, WikiLeaks

Morgan once controlled, set out to create a new supply of these so-called junk bonds by persuading companies that never before had access to the capital markets—where companies go to get capital from public investors as opposed to trying to get it from banks—to issue bonds underwritten by Drexel Burnham. Not only did Drexel underwrite these bonds for corporations that could not get financing from more traditional sources—banks, insurance companies, and the public-equity markets—but it also pioneered the selling of junk bonds to help corporate raiders, like Carl Icahn and T. Boone Pickens, get the capital they needed to take over companies such as TWA and Gulf Oil, which they would otherwise have been unable to do, and to help private-equity firms, such as Kohlberg Kravis Roberts and the Texas Pacific Group, get the money they needed to buy companies with their investors’ money.

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But Milken was worth what he was being paid because Drexel was reaping billions of dollars in fees from his extraordinary innovation. Drexel dominated the junk-bond market for years before Milken’s Wall Street brethren deconstructed what he was doing, copied him, and started competing with him. During his Wall Street career (before he was banned from it for life), Milken financed more than thirty-two hundred companies across a wide swath of industries, household names that likely wouldn’t have existed without the money he raised for them. Drexel’s first junk-bond financing, in April 1977, was a $30 million bond for Texas International, a small oil-exploration company.

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Countless other companies, financed by investment banks other than Drexel, probably wouldn’t exist without the high-yield market that Milken created. It’s not hyperbole to say that junk bonds underwritten by Wall Street firms have created millions of jobs that otherwise might not have existed, along with billions, if not trillions, of dollars in accumulated wealth. Of course, nothing leads to excess like success. For years, Milken’s power in the junk-bond market was near absolute. Unfortunately, he used it to line his own pockets at the expense of his clients and of his firm, Drexel Burnham. He regularly siphoned off big fees for himself and would take the valuable equity positions in companies that he demanded in order to get deals done instead of passing them along to investors.

Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", Albert Einstein, anti-communist, asset allocation, Bear Stearns, beat the dealer, Benoit Mandelbrot, Black Monday: stock market crash in 1987, Black-Scholes formula, Bletchley Park, Brownian motion, buy and hold, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, Edward Thorp, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial engineering, Henry Singleton, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John Meriwether, John von Neumann, junk bonds, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Michael Milken, Myron Scholes, New Journalism, Norbert Wiener, offshore financial centre, Paul Samuelson, publish or perish, quantitative trading / quantitative finance, random walk, risk free rate, risk tolerance, risk-adjusted returns, Robert Shiller, Ronald Reagan, Rubik’s Cube, short selling, speech recognition, statistical arbitrage, Teledyne, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond, zero-sum game

He christened these unloved securities “junk bonds.” He began selling them aggressively at his employer, the investment bank Drexel Burnham Lambert. Milken was such a superb salesman that in time he largely nullified Hickman’s reason for buying junk bonds. At the height of Milken’s influence, junk bonds had become so popular, and were selling at such elevated prices, that the conclusions of the Hickman and Atkinson studies probably no longer applied. Milken had ideas of his own. One was that companies with doubtful credit could issue their own “junk bonds” at high interest rates. The companies would use the capital to buy other companies and sell off their assets to pay the bond interest.

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They wanted to buy back most of the stock issued, limiting ownership to the few biggest shareholders. To get the necessary money, Warner Communications would have to issue junk bonds. Ross asked Michael Milken for advice. Milken devised a plan and met with Ross in New York to discuss it. Milken explained that Ross would have to give up 40 percent of Warner’s stock as an inducement to get people to buy the junk bonds. This was a standard equity kicker. People would not buy these junk bonds unless they also got stock. Drexel would get another 35 percent cut of the company’s stock as payment for services rendered. That left a mere 25 percent of the company for Ross’s group.

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investor when Sharpe taught at UC Irvine. Now he had a track record. Thorp described some of the trades he’d made to Sharpe. One was a 1974 trade in an American Motors Corporation (AMC) convertible bond maturing in 1988. Issued at $1,000, the bond had sunk to $600. That gave it a high return—it was a convertible junk bond. The bond could be exchanged for 100 shares of AMC stock. The stock was then selling for $6 a share. The bond therefore sold for exactly the same price as the stock you could get by converting it. That was insane, Thorp realized. The bond paid 5 percent interest. The stock paid no dividends. Owning the bond gave all the upside potential of owning the stock.

Wall Street: How It Works And for Whom by Doug Henwood

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, affirmative action, Alan Greenspan, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, bond market vigilante , book value, borderless world, Bretton Woods, British Empire, business cycle, buy the rumour, sell the news, capital asset pricing model, capital controls, Carl Icahn, central bank independence, computerized trading, corporate governance, corporate raider, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, currency risk, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, disinformation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial engineering, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, Glass-Steagall Act, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, information asymmetry, interest rate swap, Internet Archive, invisible hand, Irwin Jacobs, Isaac Newton, joint-stock company, Joseph Schumpeter, junk bonds, kremlinology, labor-force participation, late capitalism, law of one price, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, long and variable lags, Louis Bachelier, low interest rates, market bubble, Mexican peso crisis / tequila crisis, Michael Milken, microcredit, minimum wage unemployment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, oil shock, Paul Samuelson, payday loans, pension reform, planned obsolescence, plutocrats, Post-Keynesian economics, price mechanism, price stability, prisoner's dilemma, profit maximization, proprietary trading, publication bias, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Savings and loan crisis, selection bias, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, stock buybacks, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond

Regan concluded, "If you're not in high ttax] brackets and don't own these bonds, you lose every time your state or local government borrows," since the municipal subsidy means higher federal taxes (or reduced federal services) for the non-bondholder. corporations and the erosion of commitment Corporate bonds are the last major type. The market is large — at $3.3 trillion in 1997, starting to approach the U.S. Treasury market in size — but doesn't trade anywhere near as frenetically, and hasn't made much news since the junk bond boom and bust of the 1980s. Annual turnover amounts to only a few days' worth of Treasury action. While nonfinancial corporate bond debt has grown impressively — from an amount equal to 13% of GDP in 1980 to 18% in 1997 — financial firms were busier issuers, rising from 3% of GDP to 17% over the same period.

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The more reality INSTRUMENTS financial innovations adjustable rate convertible notes • adjustable rate preferred stock • adjustable/variable rate mortgages • All-Saver certificates • Annericus trust • annuity notes • auction rate capital notes • auction rate notes/debentures • auction rate preferred stock • bull and bear CDs • capped floating rate notes • collateralized connmercial paper • collateralized nnortgage obligations/real estate mortgage investment conduits • collateralized preferred stock • commercial real estate-backed bonds • commodity-linked bonds • convertible adjustable preferred stock • convertible exchangeable preferred stock • convertible mortgages/reduction option loans • convertible reset debentures • currency swaps • deep discount/zero coupon bonds • deferred interest debentures • direct public sale of securities • dividend reinvestment plan • dollar BILS • dual currency bonds • employee stock ownership plan (ESOP) • Eurocurrency bonds • Euronotes/Euro-commercial paper • exchangeable auction rate preferred stock • exchangeable remarketed preferred stock • exchangeable variable rate notes • exchange-traded options • extendible notes • financial futures • floating rate/adjustable rate notes • floating rate extendible notes • floating rate, rating sensitive notes • floating rate tax-exempt notes • foreign-currency-denominated bonds • foreign currency futures and options • forward rate agreements • gold loans • high-yield (junk) bonds • increasing rate notes • indexed currency option notes/ principal exchange linked securities • indexed floating rate preferred stock • indexed sinking fund debentures • interest rate caps/collars/floors • interest rate futures • interest rate reset notes • interest rate swaps • letter of credit/surety bond support • mandatory convertible/equity contract notes • master limited partnership • medium-term notes • money market notes • mortgage-backed bonds • mortgage pass-through securities • negotiable CDs • noncallable long-term bonds • options on futures contracts • paired common stock • participating bonds • pay-in-kind debentures • perpetual bonds • poison put bonds • puttable/adjustable tender bonds • puttable common stock • puttable convertible bonds • puttable-extendible notes • real estate-backed bonds • real yield securities • receivable-backed securities • remarketed preferred stock • remarketed reset notes • serial zero-coupon bonds • shelf registration process • single-point adjustable rate stock • Standard & Poor's indexed notes • state rate auction preferred stock • step-up put bonds • stock index futures and options • stripped mortgage-backed securities • stripped municipal securities • stripped U.S.

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Henry Kravis, the major figure of the leveraged buyout mania, did make it to the chair of New York City's public TV station and the board of the Metropolitan Museum, the latter an inner sanctum of the Establishment — but Kravis' father was rich and well-connected on Wall Street, even if he was from Oklahoma (Bartlett 1991). Many 1980s hotshots have disappeared from the headlines; one, Kirk Kerkorian, made a pass at Chrysler in the spring of 1995, but wasn't taken seriously, because there was no longer any Drexel Burnham Lambert around to float junk bonds in his name. Boone Pickens' firm, Mesa Petroleum, is in terrible shape, and his shareholders booted him out. Alumni of the financing arm of the upstarts, the now-dead Drexel, are scattered around Wall Street, but they're no longer financing a New Class's claims to power. In the old days, investment banking was much more about connections — who roomed with whom at Andover could determine both partnerships and client relationships.

Transaction Man: The Rise of the Deal and the Decline of the American Dream by Nicholas Lemann

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, Abraham Maslow, Affordable Care Act / Obamacare, Airbnb, airline deregulation, Alan Greenspan, Albert Einstein, augmented reality, basic income, Bear Stearns, behavioural economics, Bernie Sanders, Black-Scholes formula, Blitzscaling, buy and hold, capital controls, Carl Icahn, computerized trading, Cornelius Vanderbilt, corporate governance, cryptocurrency, Daniel Kahneman / Amos Tversky, data science, deal flow, dematerialisation, diversified portfolio, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, Fairchild Semiconductor, financial deregulation, financial innovation, fixed income, future of work, George Akerlof, gig economy, Glass-Steagall Act, Henry Ford's grandson gave labor union leader Walter Reuther a tour of the company’s new, automated factory…, Ida Tarbell, index fund, information asymmetry, invisible hand, Irwin Jacobs, Joi Ito, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kickstarter, life extension, Long Term Capital Management, Mark Zuckerberg, Mary Meeker, mass immigration, means of production, Metcalfe’s law, Michael Milken, money market fund, Mont Pelerin Society, moral hazard, Myron Scholes, Neal Stephenson, new economy, Norman Mailer, obamacare, PalmPilot, Paul Samuelson, Performance of Mutual Funds in the Period, Peter Thiel, price mechanism, principal–agent problem, profit maximization, proprietary trading, prudent man rule, public intellectual, quantitative trading / quantitative finance, Ralph Nader, Richard Thaler, road to serfdom, Robert Bork, Robert Metcalfe, rolodex, Ronald Coase, Ronald Reagan, Sand Hill Road, Savings and loan crisis, shareholder value, short selling, Silicon Valley, Silicon Valley ideology, Silicon Valley startup, Snow Crash, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, TaskRabbit, TED Talk, The Nature of the Firm, the payments system, the strength of weak ties, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, too big to fail, transaction costs, universal basic income, War on Poverty, white flight, working poor

Milken also developed a client base for junk bonds in a group of western savings and loan companies that were looking for a source of capital that they could use to make risky but potentially highly profitable loans to commercial real estate developers. Often these savings and loan clients of Milken’s would be both buyers and sellers of his junk bonds: he’d offer them junk-bond financing to pay for their own expansionist schemes, on the condition that they’d purchase other junk-bond issues of Drexel’s. Other people would buy junk bonds issued by Milken on behalf of the savings and loans, and the savings and loans would buy junk bonds issued by Milken on behalf of companies that were clients of his, at artificially inflated prices. (It was this sort of arrangement that eventually landed Milken in jail and Drexel Burnham in bankruptcy.)

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Milken saw that the bond markets were no longer the province of buy-and-hold trust officers and insurance companies; he created a market for high-risk, high-yield “junk bonds” that in the old days nobody would have wanted. Selling junk bonds to the new breed of fixed-income traders on Wall Street generated much of the capital that fueled the mergers and acquisitions business in the 1980s, and of course the nature of the financing meant that successful acquirers of companies were heavily in debt. Milken also developed a client base for junk bonds in a group of western savings and loan companies that were looking for a source of capital that they could use to make risky but potentially highly profitable loans to commercial real estate developers.

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Jensen himself, on fire with the ideas he had developed, began working in a more public, less technical, more opinionated vein. Within a few years, he had become the leading public advocate and justifier of a number of new techniques in the financial world that suddenly became pervasive: a large increase in mergers and acquisitions, including hostile ones; the development of the junk-bond market, whose high-risk, high-return instruments often financed these activities; enormous raises in the compensation of corporate chief executives, often in the form of stock options; the onset of leveraged buyouts and private equity as ways for financiers to take direct, usually temporary control of formerly publicly held companies.

Who Needs the Fed?: What Taylor Swift, Uber, and Robots Tell Us About Money, Credit, and Why We Should Abolish America's Central Bank by John Tamny

Airbnb, Alan Greenspan, Apollo 13, bank run, Bear Stearns, Bernie Madoff, bitcoin, Bretton Woods, business logic, buy and hold, Carl Icahn, Carmen Reinhart, corporate raider, correlation does not imply causation, cotton gin, creative destruction, Credit Default Swap, crony capitalism, crowdsourcing, Donald Trump, Downton Abbey, Fairchild Semiconductor, fiat currency, financial innovation, Fractional reserve banking, full employment, George Gilder, Glass-Steagall Act, Home mortgage interest deduction, Jeff Bezos, job automation, Joseph Schumpeter, junk bonds, Kenneth Rogoff, Kickstarter, Larry Ellison, liquidity trap, low interest rates, Mark Zuckerberg, market bubble, Michael Milken, Money creation, money market fund, moral hazard, mortgage tax deduction, NetJets, offshore financial centre, oil shock, peak oil, Peter Thiel, Phillips curve, price stability, profit motive, quantitative easing, race to the bottom, Ronald Reagan, self-driving car, sharing economy, Silicon Valley, Silicon Valley startup, Solyndra, Steve Jobs, The Wealth of Nations by Adam Smith, too big to fail, Travis Kalanick, Uber for X, War on Poverty, yield curve

For a company to expand and frequently create the jobs that come with that expansion, there must be savers first. Banks and investment banks are paid handsomely for bringing the two together. Going back to Michael Milken, while he cleaned the clocks of investment banks that turned their noses up at “junk bonds,” ultimately those same banks learned from their mistakes. Now, they all have junk-bond or “high-yield” bankers who raise money for the riskier business concepts willing to pay higher rates of interest in return for credit. Most banks and investment banks have private equity arms now, too. In fact, it was a surprise during the 2012 presidential election that Mitt Romney didn’t talk more extensively about the source of his great wealth.

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Even better, new sources of credit constantly innovate around the Federal Reserve. While this will be discussed in greater detail in future sections of this book, for now it’s worth migrating to a form of finance that reached full flower around the same time that Trump rocketed to his early fame, high-yield finance. Readers may better know “high-yield bonds” as “junk bonds,” the latter being the pejorative members of the media attached to them long ago. Readers needn’t worry. There’s nothing complicated here. To understand “junk” or “high-yield” debt, let’s first imagine you have $10,000 lying around. Next, imagine that actress Jennifer Lawrence asked to borrow it.

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As Fischel describes, “Whole industries—including gambling, telecommunications, and healthcare—were financed in significant part with high-yield bonds.”14 The list of companies that were the result of Milken securing them access to credit includes MCI, CNN, Turner Broadcasting, and Occidental Petroleum.15 What’s important here is that while the Fed seeks to influence credit by exchanging dollars for bonds held by banks, which can then lend the dollars, Milken was sourcing credit for companies that banks traditionally passed over. As of 1988, at which time “junk bonds” had a much better reputation, these high-yielding instruments were but 1 percent of savings and loan assets.16 More than 95 percent of corporate debt for companies with earnings greater than $35 million (and a 100 percent of debt for companies with earnings less than $35 million) is rated “junk.”

The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein

Alan Greenspan, asset allocation, behavioural economics, book value, Bretton Woods, British Empire, business cycle, butter production in bangladesh, buy and hold, buy low sell high, carried interest, corporate governance, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dava Sobel, diversification, diversified portfolio, Edmond Halley, equity premium, estate planning, Eugene Fama: efficient market hypothesis, financial engineering, financial independence, financial innovation, fixed income, George Santayana, German hyperinflation, Glass-Steagall Act, high net worth, hindsight bias, Hyman Minsky, index fund, invention of the telegraph, Isaac Newton, John Bogle, John Harrison: Longitude, junk bonds, Long Term Capital Management, loss aversion, low interest rates, market bubble, mental accounting, money market fund, mortgage debt, new economy, pattern recognition, Paul Samuelson, Performance of Mutual Funds in the Period, quantitative easing, railway mania, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Savings and loan crisis, South Sea Bubble, stock buybacks, stocks for the long run, stocks for the long term, survivorship bias, Teledyne, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

So, if you are earning 7% more in interest per year than with a Treasury bond, but you are losing an average of 4% per year on bankruptcies, then in the end you should still be left with 3% more return than Treasuries. Most investors would consider this to be an adequate tradeoff. But it’s important to understand that during a recession, even the market value of the surviving bonds may temporarily decrease. For example, during the 1989–1990 junk bond debacle, price declines approaching 20% were common even in the healthiest issues. If you’re going to invest in junk bonds, you have to keep your eye on the yield spread between Treasuries and junk. In Figure 2-6, I’ve plotted this junk-Treasury spread (JTS) over the recent past. Note how the JTS is, more often than not, quite low—in fact, lower than even the historical loss rate!

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On the other hand, a stock fund with high turnover will periodically distribute a large amount of capital gains to you, on which taxes must be paid. Such a fund is tax-inefficient. Worst of all are REIT and junk bond funds, which distribute almost all of their return in the form of dividends. Further, these dividends are taxed at the high ordinary income rate. Obviously, then, you will want to hold only tax-efficient funds in your taxable account, reserving the most tax-inefficient ones for your retirement accounts. The problem, as we’ve already mentioned, is that certain asset classes are inherently tax-inefficient, such as junk bonds and REITs. Value funds are also relatively tax-inefficient, because if a value stock increases enough in price, it may no longer qualify for the value index and must be sold at a substantial capital gain.

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First, because sudden market downturns affect smaller investors less, because they have a smaller portion of their portfolio invested in any one asset class. I came smack up against this at a recent conference of institutional bond investors. The junk-bond money managers at the meeting were easy to pick out—they were the ones with a vacant, deer-in-the-headlights stare. Not only were junk bonds falling rapidly in price, but in most cases, market conditions were so bad that they could not even find someone to trade with. In other words, they did not even know what the bonds in their portfolios were worth. Remember, the world of institutional investing is highly specialized—junk was most of what these poor folks traded, and my guess is that many of them had recently been on the phone to Momma inquiring about the availability of their old room.

The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja, Myron Scholes, Mohamed El-Erian

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Alan Greenspan, Asian financial crisis, asset allocation, asset-backed security, backtesting, Bear Stearns, Bernie Madoff, book value, Bretton Woods, business process, call centre, Carl Icahn, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, en.wikipedia.org, family office, financial engineering, fixed income, global macro, high net worth, high-speed rail, impact investing, interest rate derivative, Isaac Newton, Jim Simons, junk bonds, Long Term Capital Management, managed futures, Marc Andreessen, Mark Zuckerberg, merger arbitrage, Michael Milken, Myron Scholes, NetJets, oil shock, pattern recognition, Pershing Square Capital Management, Ponzi scheme, proprietary trading, quantitative easing, quantitative trading / quantitative finance, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, Savings and loan crisis, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, stock buybacks, systematic bias, systematic trading, tail risk, two and twenty, zero-sum game

By 1982 he earned his MBA, then known as an MSIA or master of science in industrial administration, and began his real education: two years in the treasury department at Ohio’s Republic Steel. There, he was introduced to the junk bond market by working on financings of non–investment grade debt. In 1984 he was recruited to Keystone Mutual Funds in Boston, where he met his wife, Marlene, while she was working at Wang Laboratories. He worked as an analyst for their junk bond group for about a year before being recruited by Goldman Sachs. Through the years, Tepper has made several large donations to the University of Pittsburgh, including endowed undergraduate scholarships, university-run community outreach programs, and academic centers.

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Tepper thinks of his investment track record as something similar to a connect-the-dots game, except the puzzle is never finished and the prize is billions of dollars. “When I got to Goldman, I changed the way junk bonds were traded. It was pretty radical, moving the whole market to trades on sectors. It used to be traded by maturities, which helped perpetuate the monopoly held by Michael Milken at Drexel Burnham,” explains Tepper. This approach to the U.S. junk bond market would serve Appaloosa well in its pursuit of global opportunities. International Intrigue Venturing into the world of emerging markets in the mid-1990s was like second nature to Tepper, who had been a key player in many “different capital markets and things that were happening around the world,” he says, from his time at Goldman.

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“I think it was a little bit of hubris probably,” Lasry admits. He had learned a lot from the superstars at Bass and felt ready to invest his money on his own. What’s more, Drexel Burnham Lambert had collapsed in the wake of Michael Milken’s indictment for securities fraud, which plunged many companies with low junk bond credit ratings deeper in the red. Suddenly, there were massive opportunities for distressed investors. “You know, when you look back on it, I left what probably was one of the best jobs in America, running money for one of the world’s first billionaires,” Lasry says. “And back then there weren’t that many.

The Intelligent Investor (Collins Business Essentials) by Benjamin Graham, Jason Zweig

3Com Palm IPO, accounting loophole / creative accounting, air freight, Alan Greenspan, Andrei Shleifer, AOL-Time Warner, asset allocation, book value, business cycle, buy and hold, buy low sell high, capital asset pricing model, corporate governance, corporate raider, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, George Santayana, hiring and firing, index fund, intangible asset, Isaac Newton, John Bogle, junk bonds, Long Term Capital Management, low interest rates, market bubble, merger arbitrage, Michael Milken, money market fund, new economy, passive investing, price stability, Ralph Waldo Emerson, Richard Thaler, risk tolerance, Robert Shiller, Ronald Reagan, shareholder value, sharing economy, short selling, Silicon Valley, South Sea Bubble, Steve Jobs, stock buybacks, stocks for the long run, survivorship bias, the market place, the rule of 72, transaction costs, tulip mania, VA Linux, Vanguard fund, Y2K, Yogi Berra

That mitigates Graham’s complaints about the difficulty of diversifying. (However, his bias against high-yield preferred stock remains valid, since there remains no cheap and widely available way to spread their risks.) Since 1978, an annual average of 4.4% of the junk-bond market has gone into default—but, even after those defaults, junk bonds have still produced an annualized return of 10.5%, versus 8.6% for 10-year U.S. Treasury bonds.2 Unfortunately, most junk-bond funds charge high fees and do a poor job of preserving the original principal amount of your investment. A junk fund could be appropriate if you are retired, are looking for extra monthly income to supplement your pension, and can tolerate temporary tumbles in value.

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Here is a list for today. Junkyard Dogs? High-yield bonds—which Graham calls “second-grade” or “lower-grade” and today are called “junk bonds”—get a brisk thumbs-down from Graham. In his day, it was too costly and cumbersome for an individual investor to diversify away the risks of default.;1 (To learn how bad a default can be, and how carelessly even “sophisticated” professional bond investors can buy into one, see the sidebar on p. 146.) Today, however, more than 130 mutual funds specialize in junk bonds. These funds buy junk by the cartload; they hold dozens of different bonds. That mitigates Graham’s complaints about the difficulty of diversifying.

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A junk fund could be appropriate if you are retired, are looking for extra monthly income to supplement your pension, and can tolerate temporary tumbles in value. If you work at a bank or other financial company, a sharp rise in interest rates could limit your raise or even threaten your job security—so a junk fund, which tends to outper-forms most other bond funds when interest rates rise, might make sense as a counterweight in your 401(k). A junk-bond fund, though, is only a minor option—not an obligation—for the intelligent investor. A WORLD OF HURT FOR WORLDCOM BONDS Buying a bond only for its yield is like getting married only for the sex. If the thing that attracted you in the first place dries up, you’ll find yourself asking, “What else is there?”

Servant Economy: Where America's Elite Is Sending the Middle Class by Jeff Faux

air traffic controllers' union, Alan Greenspan, back-to-the-land, Bear Stearns, benefit corporation, Bernie Sanders, Black Swan, Bretton Woods, BRICs, British Empire, business cycle, call centre, centre right, classic study, cognitive dissonance, collateralized debt obligation, collective bargaining, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, David Brooks, David Ricardo: comparative advantage, disruptive innovation, falling living standards, financial deregulation, financial innovation, full employment, Glass-Steagall Act, guns versus butter model, high-speed rail, hiring and firing, Howard Zinn, Hyman Minsky, illegal immigration, indoor plumbing, informal economy, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, junk bonds, Kevin Roose, Kickstarter, lake wobegon effect, Long Term Capital Management, low interest rates, market fundamentalism, Martin Wolf, McMansion, medical malpractice, Michael Milken, military-industrial complex, Minsky moment, mortgage debt, Myron Scholes, Naomi Klein, new economy, oil shock, old-boy network, open immigration, Paul Samuelson, plutocrats, price mechanism, price stability, private military company, public intellectual, radical decentralization, Ralph Nader, reserve currency, rising living standards, Robert Shiller, rolodex, Ronald Reagan, Savings and loan crisis, school vouchers, Silicon Valley, single-payer health, Solyndra, South China Sea, statistical model, Steve Jobs, Suez crisis 1956, Thomas L Friedman, Thorstein Veblen, too big to fail, trade route, Triangle Shirtwaist Factory, union organizing, upwardly mobile, urban renewal, War on Poverty, We are the 99%, working poor, Yogi Berra, Yom Kippur War, you are the product

In a related debacle, the Reagan regulators looked on benignly while reputable firms like Salomon Brothers created the junk bond securities that were hyped by slick salesmen as safe and high yielding. High yielding they were, but hardly safe. The junk bonds were the fuel that fired the merger and leverage buyout bubbles in the 1980s. In a leveraged buyout, investors and specialized private equity investment firms buy controlling interests in a well-run company with little debt and a healthy cash flow. They pay for the company not with their own money but with loans, such as junk bonds, that put up the company’s assets as collateral, burdening the firm with debt.

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But throughout the buildup of the great leveraged buyout bubble of the 1980s, such as in the dot-com bubble of the 1990s and the subprime mortgage bubble of 2000–2008, Wall Street assured itself and its customers that the rewards of these exotic schemes were coming at little or no risk. Moreover, their customers were often not just the average small investor but people in charge of large institutions, including pension funds, responsible for huge pools of money. When the junk bond–propelled market inevitably crashed in 1987, the Federal Reserve promptly flooded the market with cheap loans, keeping companies that should have been bankrupt afloat. Junk bond king Michael Milken was eventually indicted on ninety-six counts, including insider trading, illegal profiteering, and tax evasion. But the actual lesson was that crime pays. It cost Milken about six hundred million dollars in penalties, but he got to keep about a billion dollars for himself after spending less than two years in a minimum-security prison.

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It inspired immigrants to cross the sea in stinking ships and pioneers to cross the continent in rickety wagons. Optimism built the great industrial and financial enterprises that made the country the world’s preeminent power. It motivated people to invest against all odds in restaurants, hi-tech start-ups, and initial public offerings that were issued by companies they’d never heard of and labeled “junk bonds.” Optimism nurtured George Washington at Valley Forge and Abraham Lincoln in the darkest days of the Civil War. It was Roosevelt’s trump card against the Depression. It stiffened the resolve of labor leader Eugene Debs in an Atlanta prison and Martin Luther King Jr. in a Birmingham jail. It sustained the suffragist when prison guards pumped a force-feeding tube down her throat.

For Profit: A History of Corporations by William Magnuson

"Friedman doctrine" OR "shareholder theory", activist fund / activist shareholder / activist investor, Airbnb, bank run, banks create money, barriers to entry, Bear Stearns, Big Tech, Black Lives Matter, blockchain, Bonfire of the Vanities, bread and circuses, buy low sell high, carbon tax, carried interest, collective bargaining, Cornelius Vanderbilt, corporate raider, creative destruction, disinformation, Donald Trump, double entry bookkeeping, Exxon Valdez, fake news, financial engineering, financial innovation, Ford Model T, Ford paid five dollars a day, Frederick Winslow Taylor, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Ida Tarbell, Intergovernmental Panel on Climate Change (IPCC), invisible hand, joint-stock company, joint-stock limited liability company, junk bonds, Mark Zuckerberg, Menlo Park, Michael Milken, move fast and break things, Peter Thiel, power law, price discrimination, profit maximization, profit motive, race to the bottom, Ralph Waldo Emerson, randomized controlled trial, ride hailing / ride sharing, scientific management, Sheryl Sandberg, Silicon Valley, Silicon Valley startup, slashdot, Snapchat, South Sea Bubble, spice trade, Steven Levy, The Wealth of Nations by Adam Smith, Thomas L Friedman, Tim Cook: Apple, too big to fail, trade route, transcontinental railway, union organizing, work culture , Y Combinator, Yom Kippur War, zero-sum game

Operating out of his Beverly Hills office, Milken developed a market for so-called junk bonds, risky debt issued by debt-laden or struggling companies. Junk bonds had long been considered off-limits to most mainstream investors. They were considered too risky and too unlikely to pay off. But Milken became convinced—and, more importantly, convinced buyers—that if he could package these junk bonds together into a portfolio, they would outperform the bonds of more conservative, stable companies. Milken’s junk bond business was soon helping companies issue billions of dollars in debt every year—in 1983 alone, Drexel sold $4.7 billion in junk bonds. But the real supercharger behind junk bonds was the rise of leveraged buyouts.

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But the real supercharger behind junk bonds was the rise of leveraged buyouts. KKR realized that junk bonds could finance their acquisitions, allowing them to raise more debt, for less, and faster. In 1984, KKR accepted a bid from Milken to finance its $330 million acquisition of Cole National, an eyewear and toy company, and Kravis was shocked by how easily Milken found buyers for the risky debt. It was “the damnedest thing I’d ever seen,” Kravis said. For the rest of the decade, KKR and Drexel would form an inseparable duo. Between 1984 and 1989, KKR used Drexel for thirteen transactions, and KKR, in turn, was Drexel’s largest borrower.

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Various reform proposals were bandied about, from abolishing tax deductions on interest from junk bonds to creating tax deductions for dividend payments. But all were shot down. The only effective brake on private equity’s acceleration were two unrelated developments at the turn of the decade. The first was a rise in interest rates in the wider economy. Higher interest rates made debt more expensive, thereby making it harder for private equity firms like KKR to load their portfolio companies with bonds. The second development came when Michael Milken, the undisputed champion of junk bonds, was indicted for conspiracy and fraud in connection with his securities work.

The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance by Ron Chernow

Alan Greenspan, always be closing, bank run, banking crisis, Bear Stearns, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, Bolshevik threat, book value, Boycotts of Israel, Bretton Woods, British Empire, buy and hold, California gold rush, capital controls, Carl Icahn, Charles Lindbergh, collective bargaining, Cornelius Vanderbilt, corporate raider, death from overwork, Dutch auction, Etonian, financial deregulation, financial engineering, fixed income, German hyperinflation, Glass-Steagall Act, index arbitrage, interest rate swap, junk bonds, low interest rates, margin call, Michael Milken, military-industrial complex, money market fund, Monroe Doctrine, North Sea oil, oil shale / tar sands, old-boy network, paper trading, plutocrats, Robert Gordon, Ronald Reagan, short selling, stock buybacks, strikebreaker, Suez canal 1869, Suez crisis 1956, the market place, the payments system, too big to fail, transcontinental railway, undersea cable, Yom Kippur War, young professional

As its underwriting business declined, Morgan Stanley turned to businesses it once would have rejected haughtily, entering the netherworld of junk bonds. These high-risk high-yield bonds were often issued to support takeovers by companies of questionable solidity. The new junk bond department coincided with Morgan Stanley’s sudden interest in small start-up companies. As Bob Greenhill explained, “Morgan was building a high-technology effort at that time, and I said, ‘How can we not be in a business that is so necessary for so many of our growing clients?’ ”31 Junk bonds revolutionized Wall Street by magnifying the money available to corporate raiders. Where conglomerate takeovers in the 1960s used share exchanges, and cash was the method of choice in the 1970s, the junk bond market let corporate raiders flout the Wall Street establishment and finance their incursions by selling bonds to investors.

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With considerable hoopla, Morgan Stanley talked about gentrifying junk bonds, but self-congratulation proved premature. In mid-1982, Morgan Stanley joined with Hambrecht and Quist to sponsor the first public offerings of People Express, the pioneering no-frills discount airline. Buying up used Lufthansa planes and ripping out their first-class sections, People founder Donald C. Burr wanted to create cheap air travel for the masses; his feisty, hustling airline was the anti-thesis of a classic Morgan client. Between 1983 and 1986, Morgan Stanley underwrote more than $500 million in junk bonds for People. As if still leary of its junk bond departure, the firm overruled custom and let Charles G.

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After the crash, it de-emphasized securities distribution and edged out dozens of managing directors, largely from the sales and trading side. In 1988, Merrill Lynch, once scorned as plebeian, led domestic underwriters for the first time as Morgan Stanley slumped to sixth place. Morgan mostly pursued junk bonds, now the most profitable form of underwriting and an indispensable adjunct to takeover work. When Drexel Burnham lost ground with the investigation into junk bond king Michael Milken, Morgan Stanley briefly emerged as the top junk bond firm in America! Did the ghosts of Pierpont, Jack, and Harry Morgan shudder? Morgan Stanley was an undoubted success story, an awesome performer. For over fifty years, it had stood at or near the peak of investment banking—a claim no other firm except First Boston could make.

Devil's Bargain: Steve Bannon, Donald Trump, and the Storming of the Presidency by Joshua Green

4chan, Affordable Care Act / Obamacare, Ayatollah Khomeini, Bernie Sanders, Biosphere 2, Black Lives Matter, business climate, Cambridge Analytica, Carl Icahn, centre right, Charles Lindbergh, coherent worldview, collateralized debt obligation, conceptual framework, corporate raider, crony capitalism, currency manipulation / currency intervention, data science, Donald Trump, Dr. Strangelove, fake news, Fractional reserve banking, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Gordon Gekko, guest worker program, hype cycle, illegal immigration, immigration reform, Jim Simons, junk bonds, liberation theology, low skilled workers, machine translation, Michael Milken, Nate Silver, Nelson Mandela, nuclear winter, obamacare, open immigration, Peace of Westphalia, Peter Thiel, quantitative hedge fund, Renaissance Technologies, Robert Mercer, Ronald Reagan, Silicon Valley, social intelligence, speech recognition, Steve Bannon, urban planning, vertical integration

These higher interest rates meant that a portfolio of fallen angels, even though some would go bust, would almost invariably beat a portfolio of blue-chip bonds. Yet most investors shunned them as “junk.” Milken’s insight was that junk bonds were undervalued assets because investors, who feared seeming imprudent, didn’t want to own them. An enormous opportunity awaited someone less constrained by appearances. Milken made himself rich by trading junk bonds. Then he made himself vastly richer by becoming the chief evangelist for their cause. Along the way, he upended U.S. corporate finance. By convincing other investors that junk bonds were a shrewd bet, Milken almost single-handedly created a market for them. The demand he created meant that two types of businesses considered too risky to lend to by commercial bankers—new, smaller businesses and large, struggling corporations—could suddenly gain access to capital by floating junk bonds.

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The demand he created meant that two types of businesses considered too risky to lend to by commercial bankers—new, smaller businesses and large, struggling corporations—could suddenly gain access to capital by floating junk bonds. Some of them failed. But many junk-fueled corporations, such as MCI and Chrysler, hit it big. And even though he won extraordinary wealth and renown, Milken had the chutzpah to style himself a populist, conjuring up capital for businesses that were looked down on and refused by established lenders. By the time Bannon graduated from HBS, Milken’s revolution had generated tens of billions of dollars in junk bonds, enough to fund all the companies shut out of the credit markets. So Milken and his firm, Drexel Burnham Lambert, devised an ingenious new use for them: they used junk bonds to finance raids on undervalued blue-chip corporations.

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So Milken and his firm, Drexel Burnham Lambert, devised an ingenious new use for them: they used junk bonds to finance raids on undervalued blue-chip corporations. Milken and Drexel would fund these hostile takeovers by pledging the assets of the target corporation as collateral, in the same way that a home buyer obtains a mortgage by pledging the collateral of the home against the loan. This practice gave rise to an army of corporate raiders, men such as Ron Perelman, Carl Icahn, T. Boone Pickens, and Nelson Peltz, who became rich selling junk bonds through Drexel Burnham to finance predatory raids on such Fortune 100 companies as TWA, Disney, Revlon, and Phillips Petroleum.

Capital Ideas: The Improbable Origins of Modern Wall Street by Peter L. Bernstein

Albert Einstein, asset allocation, backtesting, Benoit Mandelbrot, Black Monday: stock market crash in 1987, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, corporate raider, debt deflation, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, full employment, Glass-Steagall Act, Great Leap Forward, guns versus butter model, implied volatility, index arbitrage, index fund, interest rate swap, invisible hand, John von Neumann, Joseph Schumpeter, junk bonds, Kenneth Arrow, law of one price, linear programming, Louis Bachelier, mandelbrot fractal, martingale, means of production, Michael Milken, money market fund, Myron Scholes, new economy, New Journalism, Paul Samuelson, Performance of Mutual Funds in the Period, profit maximization, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk free rate, risk/return, Robert Shiller, Robert Solow, Ronald Reagan, stochastic process, Thales and the olive presses, the market place, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, transfer pricing, zero-coupon bond, zero-sum game

Miller returned to it in his Nobel Prize address in Stockholm in December 1990 when he admitted that his positive view of the leveraged buyouts of the 1980s is still “far from universally accepted among the wider public.”21 But he remains unrepentant. He argues that losses on junk bonds were no proof that over-leveraging had occurred and that increased leveraging by corporations does not imply increased risk for the economy as a whole. He points out that the buyers of junk bonds knew they were taking outsize risks. Why else would they have demanded such high interest rates? “For all save the hopelessly gullible,” these investors were fully aware that some of the junk bonds would end up in default. Their expectation, consistent with orthodox finance theory, was simply that the return they would earn from taking these risks, after defaults, would be larger than if they had bought riskless bonds instead.

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The futures market alone has expanded by 12 percent a year since 1985. At this writing, new exchanges to handle these kinds of instruments are under development in London, Paris, Hong Kong, Sydney, Toronto, Singapore, Brazil, Osaka, Zurich, Frankfurt, and Tokyo. The junk bond market, the most controversial of the markets of the 1980s, flourished because it satisfied the needs of both the investors who bought junk bonds and the relatively small companies that issued them. The issuers did not want to dilute their ownership by selling more stock, but they needed capital that their banks either could not or would not supply. The buyers would have been reluctant to buy shares in small, unknown companies, but they were willing to provide capital that offered a higher yield and less risk than common stock.

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Milken recognized that the parties could do business. No one was fooled that these were triple-A obligations, but the high interest rates seemed to compensate for the risks involved. Many small companies got financing and created new jobs that would have been impossible without the junk bond market. Most of the junk bonds that subsequently defaulted were issued to finance takeovers rather than to finance the expansion of smaller corporations. ••• Although the revolution inspired by the new theories of finance has been profound, it has been less than total. Nor has the investment world split into faithful users of the new methodology and inflexible believers in the orthodox approach.

The Lords of Easy Money: How the Federal Reserve Broke the American Economy by Christopher Leonard

2021 United States Capitol attack, Affordable Care Act / Obamacare, Airbnb, Alan Greenspan, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, collateralized debt obligation, coronavirus, corporate governance, COVID-19, Donald Trump, Dutch auction, financial engineering, financial innovation, fixed income, Ford Model T, forensic accounting, forward guidance, full employment, glass ceiling, Glass-Steagall Act, global reserve currency, Greenspan put, hydraulic fracturing, income inequality, inflation targeting, Internet Archive, inverted yield curve, junk bonds, lockdown, long and variable lags, Long Term Capital Management, low interest rates, manufacturing employment, market bubble, Money creation, mortgage debt, new economy, obamacare, pets.com, power law, proprietary trading, quantitative easing, reserve currency, risk tolerance, Robinhood: mobile stock trading app, Ronald Reagan, Silicon Valley, stock buybacks, too big to fail, yield curve

Global investment banking fees rose steadily as QE money was pouring into the financial system, hitting a monthly peak of $11.1 billion in June 2014, surpassing the previous record of $10.7 billion, set in the summer of 2007, right before the crash. It was around this time, in 2014, that a junk bond analyst named Vicki Bryan noticed a pivotal change in the market for corporate debt. The old rules of junk debt and leveraged loans didn’t seem to apply anymore. “The market became disjointed, completely, from economic reality,” Bryan recalled. Her job, as a junk bond analyst, was to hunt for fraud or incompetence at the companies that borrowed junk debt and then warn her clients about it. Her entire business model relied on the fact that when analysts released important information, it affected the market.

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In some ways, the economic weakness was hidden. The economy was growing, and the dark days of Volcker’s interest-rate hikes and high unemployment were long forgotten. The mid-to-late 1980s had been a gold rush on Wall Street characterized by massive borrowing and gluttonous spending. This was the era of the junk-bond kings, who used cheap debt to buy companies and then merge them with other companies for a profit, or break them up for a quick sale. But there was an underlying weakness beneath the churning markets that was visible to millions of working Americans. Gas prices were high, layoffs were common, and business investment was slow.

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Rising yields on Treasurys meant that Wall Street might have a savings account again, and investors didn’t need to keep their money out on the risky side of the yield curve. When this fact was apparent, investors turned around and looked at all the risky junk they’d bought, like leveraged loans and corporate junk bonds. They could now dump those investments and put their money somewhere safer. This was what started happening in late June and early July. And it happened in the kinds of arcane markets where the Fed’s QE money flowed. Real estate investment trusts (REITs) began force-selling their holdings as mortgage rates adjusted.

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson, James Kwak

Alan Greenspan, American ideology, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, Bonfire of the Vanities, bonus culture, book value, break the buck, business cycle, business logic, buy and hold, capital controls, Carmen Reinhart, central bank independence, Charles Lindbergh, collapse of Lehman Brothers, collateralized debt obligation, commoditize, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency risk, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial engineering, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Glass-Steagall Act, Gordon Gekko, greed is good, Greenspan put, Home mortgage interest deduction, Hyman Minsky, income per capita, information asymmetry, interest rate derivative, interest rate swap, junk bonds, Kenneth Rogoff, laissez-faire capitalism, late fees, light touch regulation, Long Term Capital Management, low interest rates, market bubble, market fundamentalism, Martin Wolf, Michael Milken, money market fund, moral hazard, mortgage tax deduction, Myron Scholes, Paul Samuelson, Ponzi scheme, price stability, profit maximization, proprietary trading, race to the bottom, regulatory arbitrage, rent-seeking, Robert Bork, Robert Shiller, Ronald Reagan, Saturday Night Live, Satyajit Das, Savings and loan crisis, sovereign wealth fund, Tax Reform Act of 1986, The Myth of the Rational Market, too big to fail, transaction costs, Tyler Cowen, value at risk, yield curve

This process began in the 1970s, when Michael Milken, a trader at Drexel Burnham Lambert, had the insight that “junk bonds”—bonds that were rated below “investment grade” by the credit rating agencies*—were generally underpriced, either because investors had an irrational aversion to them or because they lacked a liquid market in which to trade them. He capitalized on that market inefficiency, building an operation that dominated the trading and sales of junk bonds. By creating a large, liquid market for junk bonds—which grew from $6 billion in 1970 to $210 billion in 198965—he made it easier for companies to raise money and opened up vast new opportunities for investment banks to generate profits by underwriting, selling, and trading these formerly neglected bonds.

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Germain Depository Institutions Act—hailed by President Reagan as “the first step in our administration’s comprehensive program of financial deregulation”53—which lifted many regulations on the savings and loan industry, allowing them to expand further into new businesses, such as commercial lending and investing in corporate bonds (including junk bonds), to compensate for the collapse of the “boring banking” business model.54 In addition, the bill authorized state-chartered banks to offer mortgages with adjustable rates55 (national banks had been able to offer adjustable rate mortgages since the previous year)56—a central feature of the last twenty-five years of innovation in residential lending—and relaxed other constraints on mortgage lending for national banks.

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By creating a large, liquid market for junk bonds—which grew from $6 billion in 1970 to $210 billion in 198965—he made it easier for companies to raise money and opened up vast new opportunities for investment banks to generate profits by underwriting, selling, and trading these formerly neglected bonds. By making it easy to raise large amounts of money quickly, junk bonds also made possible the leveraged buyout craze of the 1980s, in which acquirers would pay for acquisitions by issuing large amounts of new debt. Those acquisitions, in turn, generated huge fees for the investment banks that advised the companies engaged in those transactions and also underwrote and sold the necessary debt. They also left companies struggling with huge debt burdens, often requiring painful restructuring and sometimes leading to bankruptcy.

The End of Wall Street by Roger Lowenstein

"World Economic Forum" Davos, Alan Greenspan, Asian financial crisis, asset-backed security, bank run, banking crisis, Bear Stearns, benefit corporation, Berlin Wall, Bernie Madoff, Black Monday: stock market crash in 1987, Black Swan, break the buck, Brownian motion, Carmen Reinhart, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, fear of failure, financial deregulation, financial engineering, fixed income, geopolitical risk, Glass-Steagall Act, Greenspan put, high net worth, Hyman Minsky, interest rate derivative, invisible hand, junk bonds, Ken Thompson, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, low interest rates, margin call, market bubble, Martin Wolf, Michael Milken, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, Ponzi scheme, profit motive, race to the bottom, risk tolerance, Ronald Reagan, Rubik’s Cube, Savings and loan crisis, savings glut, short selling, sovereign wealth fund, statistical model, the payments system, too big to fail, tulip mania, Y2K

Its shares, financed largely with credit, rose tenfold in a single year in 1720. Then they collapsed, triggering bankruptcies and ruin. Or the Wall Street crash of 1929; stock speculation on credit helped to make the collapse so devastating. In the 1980s, corporations like Federated Department Stores palmed off junk bonds on which the interest due was far greater than their earnings.25 The utter implausibility of their promises did not deter investors—until Federated and a wave of others filed for bankruptcy. It was not so much belief as a desire to believe. As long as the market is liquid, open to fresh injections of credit, the day of reckoning need never come, or such is the hope.

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After two years, he was accepted to Harvard Business School, where GM gave him a merit scholarship, and where he received stellar grades. After getting his MBA, O’Neal returned to GM, working in the treasury department. In 1986 he joined Merrill, and by the early ’90s he was running its leveraged finance unit. O’Neal was exceptionally smart and coolly—at times brutally—ambitious. He excelled in business lines such as junk bonds, demonstrating his tolerance for risk, and was a perceptive critic of Merrill’s failings, pointing out how it could cut costs. He became CEO in 2003, accelerating his ascent by forcing the early departure of his predecessor and former mentor. Even after he reached the top, there remained in the tall, graying O’Neal something of the perpetual outsider.

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In December, Goldman lost money in mortgage securities for ten days running, and though the amount it lost wasn’t great, this kind of rough patch was unusual. David Viniar and Gary Cohn, the firm’s chief financial officer and chief operating officer, received a profit-and-loss report from every Goldman business every day; after two weeks of losses they had seen enough. At the same time, issuance of corporate junk bonds was falling fast, suggesting a general retreat from risky credits. Viniar, the heads of Goldman’s mortgage business, and various of its financial operatives, about twenty bankers in all, were summoned to a top-level powwow. The consensus was that mortgage values would get worse before they got better.

The Greed Merchants: How the Investment Banks Exploited the System by Philip Augar

Alan Greenspan, Andy Kessler, AOL-Time Warner, barriers to entry, Bear Stearns, Berlin Wall, Big bang: deregulation of the City of London, Bonfire of the Vanities, business cycle, buttonwood tree, buy and hold, capital asset pricing model, Carl Icahn, commoditize, corporate governance, corporate raider, crony capitalism, cross-subsidies, deal flow, equity risk premium, financial deregulation, financial engineering, financial innovation, fixed income, Glass-Steagall Act, Gordon Gekko, high net worth, information retrieval, interest rate derivative, invisible hand, John Meriwether, junk bonds, Long Term Capital Management, low interest rates, Martin Wolf, Michael Milken, new economy, Nick Leeson, offshore financial centre, pensions crisis, proprietary trading, regulatory arbitrage, risk free rate, Sand Hill Road, shareholder value, short selling, Silicon Valley, South Sea Bubble, statistical model, systematic bias, Telecommunications Act of 1996, The Chicago School, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, tulip mania, value at risk, yield curve

Their downfall was a sensation that damaged confidence in US capital markets and precipitated a collapse of the junk bond market in 1990.19 The junk bond crisis spread out across Wall Street and corporate America as a number of highly leveraged deals – including 1988’s landmark $23 billion takeover of RJR Nabisco by the buy-out specialists Kohlberg Kravis Roberts – struggled under the weight of debt repayments and asset write-downs.20 Surprising victims included the savings and loans institutions who, following deregulation in 1982, had loaded up with junk bonds with the backing and advice of the investment banks. When the junk bond market crashed, they were left with bucketloads of unmarketable and worthless bonds and US taxpayers were faced with a $500 billion bill to bail them out.21 The excesses of the 1980s spilled over into the 1990s.

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In the late 1980s Tom Wolfe’s bestseller Bonfire of the Vanities, Michael Douglas’s Oscar-winning portrayal of Gordon Gekko in the movie Wall Street and Michael Lewis’s tale of the Salomon Brothers jungle, Liar’s Poker, picked out some not very attractive characteristics of investment banking people.16 A crop of insider trading and market manipulation cases – notably the Boesky and Milken affairs in America and the Guinness scandal in the UK – revived old memories of greed and corruption in financial circles.17 Ivan Boesky was a prominent risk arbitrageur – someone who takes stock market positions in the hope of profiting from takeover bids – who received a prison sentence and a $100 million fine in 1986 after admitting to trading on insiders’ tips.18 Boesky was well known in financial circles but what shocked the public at large was where the trail led. Boesky turned state’s evidence and named Michael Milken as an insider dealer. Milken was the high profile investment banker who had transformed junk bonds – high risk, high yielding securities – from a backwater of the capital markets into a mainstream financial instrument. Under the leadership of Milken and the firm he worked for, Drexel Burnham Lambert, junk bonds were used to underpin the leveraged buy-outs – demergers funded largely by debt – that refinanced corporate America in the eighties. Using the draconian Racketeer-Influenced Corrupt Organizations law (RICO), US Attorney Rudolph Giuliani, who had also prosecuted Boesky, brought a criminal case against Milken and Drexel Burnham Lambert.

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And indeed it restored its reputation to such a degree that when in 2004 the founders of Google decided to list their company in a groundbreaking way, with all sorts of ethical objectives about the way they wanted ownership to work, guess who they chose to co-lead the issue? No Way In This background of financial volatility, staff turnover and scandal at Lehman, Salomon and CSFB should have provided ideal circumstances for other firms to join the top six. Drexel, Burnham in fact did so in the mid eighties on the back of Michael Milken’s junk bond revolution, but by 1990 it had collapsed when Milken was dragged into the Boesky insider dealing affair. Bankers Trust was another star that burned brightly for a while. It was eighth in 1990 and for the next three years its derivatives business helped to make it the most profitable major bank in the USA.

DIY Investor: How to Take Control of Your Investments & Plan for a Financially Secure Future by Andy Bell

asset allocation, bank run, Bear Stearns, Black Monday: stock market crash in 1987, buy and hold, collapse of Lehman Brothers, credit crunch, currency risk, diversification, diversified portfolio, estate planning, eurozone crisis, fixed income, high net worth, hiring and firing, Isaac Newton, junk bonds, Kickstarter, lateral thinking, low interest rates, money market fund, Northern Rock, passive investing, place-making, quantitative easing, selection bias, short selling, South Sea Bubble, technology bubble, transaction costs, Vanguard fund

These ratings apply equally to countries – the downgrade of a country’s investment rating can be politically and economically damaging. High-yield/junk bonds Anything rated below these levels is considered a high-yield or junk bond. These bonds, as you might have guessed, pay higher yields, but the chance of them going bust is also far higher. Furthermore, ratings agencies can downgrade high-yield bonds further, meaning their resale value will fall. The only way you should be investing in junk bonds as a DIY investor is through a high-yield bond fund, unless you really know what you are doing. table 13.1 Understanding ratings agency classifications Gilts In the more than 300 years since it was established, the Bank of England has never defaulted on any of its liabilities.

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To reflect its rather higher risk profile, anyone prepared to invest in 10-year bonds issued by the Greek government at that time earned a return of 17 per cent. Corporate bonds range from the very secure, offered by cash-rich blue chip companies, right up the risk scale to the very insecure, known as junk bonds, offered by struggling companies facing financial headwinds or early-stage companies whose prospects are unclear. Bonds had, until the turn of the century, traditionally been accessed through stockbrokers, or through unit trusts and OEICs investing in baskets of them. But the advent of online investment platforms has brought them to a wider audience of investors who are looking to beat miserable cash-on-deposit rates by taking on a little extra risk.

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Corporate bonds have been in existence for almost as long as there have been companies, with the East India Company and the Dutch East India Company both issuing bonds early in the 17th century. The first decades of the 20th century saw an increase in the issue of corporate bonds. These early issues were mainly investment-grade bonds, with appetite for junk bonds verging on the non-existent. The modern market in non-investment grade, or high-yield bonds, really took off after the financial crisis of the 1970s, when falling asset prices led to banks lending only to those companies with a strong credit rating. The 1980s saw high-yield bonds delivering excellent returns without the increased levels of defaults their yields suggested, attracting increasing numbers of investors to the asset class.

The New Economics: A Bigger Picture by David Boyle, Andrew Simms

Abraham Maslow, Alan Greenspan, Alvin Toffler, Apollo 11, Asian financial crisis, back-to-the-land, banking crisis, behavioural economics, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, Bretton Woods, capital controls, carbon footprint, carbon tax, clean water, collateralized debt obligation, colonial rule, Community Supported Agriculture, congestion charging, corporate raider, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Crossrail, delayed gratification, deskilling, digital divide, en.wikipedia.org, energy transition, financial deregulation, financial exclusion, financial innovation, full employment, garden city movement, Glass-Steagall Act, green new deal, happiness index / gross national happiness, if you build it, they will come, income inequality, informal economy, Intergovernmental Panel on Climate Change (IPCC), Jane Jacobs, John Elkington, junk bonds, Kickstarter, land bank, land reform, light touch regulation, loss aversion, mega-rich, microcredit, Mikhail Gorbachev, Money creation, mortgage debt, neoliberal agenda, new economy, North Sea oil, Northern Rock, offshore financial centre, oil shock, peak oil, pension time bomb, pensions crisis, profit motive, purchasing power parity, quantitative easing, Ronald Reagan, seigniorage, Simon Kuznets, sovereign wealth fund, special drawing rights, systems thinking, the long tail, The Wealth of Nations by Adam Smith, Thomas L Friedman, too big to fail, trickle-down economics, Vilfredo Pareto, Washington Consensus, wealth creators, working-age population

If a company had been prudent and paid off too much debt, then a raider could potentially use that as their own asset for grabbing control of the company, loading it with debt to pay for the takeover, stripping it of saleable assets and then selling the remains on. That was the role of the junk bonds, which offered high yields because of the high risk involved. The junk bond revolution was led by a California company called Drexel Burnham Lambert, whose senior executive vice president, Michael Milkin, was the so-called ‘junk bond king’. Evidence obtained from the insider trader Ivan Boesky led to Wall Street’s biggest criminal prosecution ever (at least until the Bernard Madoff affair in 2008), after which 98 indictments of fraud and racketeering were brought against Milkin.

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Evidence obtained from the insider trader Ivan Boesky led to Wall Street’s biggest criminal prosecution ever (at least until the Bernard Madoff affair in 2008), after which 98 indictments of fraud and racketeering were brought against Milkin. He was sentenced to ten years in jail and agreed to pay $600 million in fines. Without his leadership, the junk bonds faltered. It is widely believed that the temporary decline of the junk bond market led to a credit crunch that contributed to the 1990 recession. Milken was released from prison early because he had been given only 18 months to live, and now runs his own economic think tank. But one of the legacies of those years has been the defensive loading of companies WHY ARE MALAWI VILLAGERS PAYING THE MORTGAGES OF STOCKBROKERS?

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Especially in the UK, people still believe that the great institutions that underpin our lives, known as banks, are dedicated to careful scrutiny and prudent lending: in practice, these institutions – like so many others – have been hollowed out, removing those checks, as well as those bank managers who might once have scrutinized Mr Mouse’s mortgage application and rejected it earlier. It was a serious crisis, but it wasn’t exactly unprecedented. The Wall Street crash followed the great radio stocks boom. The 1987 crash followed the junk bond boom. 2 THE NEW ECONOMICS The dot.com ‘bust’ followed the dot.com boom. Now the 2008 crash has followed the property and credit boom. Although it always comes as a surprise to the people the novelist Tom Wolfe dubbed the ‘masters of the universe’, financial panic follows financial over-excitement, as surely as night follows day.1 A handful of sacrificial lambs are blamed and sometimes even gaoled; regulations are tightened and loosened again.

Stigum's Money Market, 4E by Marcia Stigum, Anthony Crescenzi

accounting loophole / creative accounting, Alan Greenspan, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Bear Stearns, Black-Scholes formula, book value, Brownian motion, business climate, buy and hold, capital controls, central bank independence, centralized clearinghouse, corporate governance, credit crunch, Credit Default Swap, cross-border payments, currency manipulation / currency intervention, currency risk, David Ricardo: comparative advantage, disintermediation, distributed generation, diversification, diversified portfolio, Dutch auction, financial innovation, financial intermediation, fixed income, flag carrier, foreign exchange controls, full employment, Glass-Steagall Act, Goodhart's law, Greenspan put, guns versus butter model, high net worth, implied volatility, income per capita, intangible asset, interest rate derivative, interest rate swap, inverted yield curve, junk bonds, land bank, large denomination, locking in a profit, London Interbank Offered Rate, low interest rates, margin call, market bubble, market clearing, market fundamentalism, Money creation, money market fund, mortgage debt, Myron Scholes, offshore financial centre, paper trading, pension reform, Phillips curve, Ponzi scheme, price mechanism, price stability, profit motive, proprietary trading, prudent man rule, Real Time Gross Settlement, reserve currency, risk free rate, risk tolerance, risk/return, Savings and loan crisis, seigniorage, shareholder value, short selling, short squeeze, tail risk, technology bubble, the payments system, too big to fail, transaction costs, two-sided market, value at risk, volatility smile, yield curve, zero-coupon bond, zero-sum game

Many observers consider the issue of the true risk level of junk bonds to be unresolved, although in recent years, low default rates for junk bonds has tilted investor opinion in favor of the junk-bond sector (the default rate for junk bonds was 2.2% in 2005, according to Moody’s). as an asset class, high-yield bonds have been embraced increasingly over the year. In any case, insurance companies, pension funds, and especially mutual funds have become big buyers of junk bonds.3 Thrifts, too, have been buyers of junk bonds. Low default rates during much of the 1990s and the early 2000s is one of the reasons for this increased acceptance. Originally, banks provided the bridge financing for LBO deals, but they would do so only if an investment banker had made a firm commitment to underwrite the high-yield bond issue that was to finance the deal long term.

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By having played an at least uninvited, if not hostile, role in the RJR Nabisco LBO and many other deals, KKR, as well as any LBO firm, risks limiting the number of CEOs who will be willing to sit down and talk with it in the future. Buyers of Junk Bonds By early 2006, the junk-bond market had swollen to $850 billion outstanding. Junk bonds, which are also commonly known as speculative-grade bonds, are sub-investment-grade bonds and thus pay a high yield relative to investment-grade bonds, and there seem to be numerous investors who believe that they can evaluate the risks inherent in such paper and pick issues that will turn out to be good investments.2 In fact, 2 The seminal work on junk-bond defaults was done by Edward I. Altman of New York University and Scott A.

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(Drexel Burnham Lambert was also an early groundbreaker in the analysis of yields and default rates on junk bonds.) The thrust of this work is that yields on these bonds are higher than required by their true risk. In April 1989, a controversial, unpublished study by Paul Asquith et al. from Harvard indicated that true default levels were substantially higher than those calculated by Altman and Namacher. The nature of the disagreement between the two studies lies in their methodologies, n.b.: Are losses to be looked at on a coincidental or cumulative basis? Many observers consider the issue of the true risk level of junk bonds to be unresolved, although in recent years, low default rates for junk bonds has tilted investor opinion in favor of the junk-bond sector (the default rate for junk bonds was 2.2% in 2005, according to Moody’s).

Limitless: The Federal Reserve Takes on a New Age of Crisis by Jeanna Smialek

Alan Greenspan, bank run, banking crisis, Bear Stearns, Berlin Wall, Bernie Sanders, bitcoin, Black Lives Matter, blockchain, Bretton Woods, business cycle, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, Colonization of Mars, coronavirus, COVID-19, crowdsourcing, cryptocurrency, decarbonisation, distributed ledger, Donald Trump, Fall of the Berlin Wall, fiat currency, financial engineering, financial innovation, financial intermediation, Fractional reserve banking, full employment, George Akerlof, George Floyd, Glass-Steagall Act, global pandemic, Henri Poincaré, housing crisis, income inequality, inflation targeting, junk bonds, laissez-faire capitalism, light touch regulation, lockdown, low interest rates, margin call, market bubble, market clearing, meme stock, Modern Monetary Theory, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Nixon shock, offshore financial centre, paradox of thrift, price stability, quantitative easing, race to the bottom, risk tolerance, Robinhood: mobile stock trading app, Ronald Reagan, secular stagnation, short squeeze, social distancing, sovereign wealth fund, The Great Moderation, too big to fail, trade route, Tragedy of the Commons, working-age population, yield curve

The way to help the junk market without helping specific companies seemed to be to buy lower-rated bonds via exchange-traded funds, or ETFs, which was akin to buying tiny slices of a huge range of debt. Unfortunately, that created another pitfall. The largest junk bond ETF was offered by BlackRock, the firm running the Fed’s programs, and it had been hit by massive outflows. By backstopping the market, the Fed would be bolstering a product tied to the very company it was paying to carry out its rescue. The calculus was one that would make any policy maker squirm. A broad, fund-based junk bond purchase program was likely to be quick and efficient. It would probably work. It was guaranteed to look terrible. It was the hardest decision in a crisis full of them, but the positives carried the day.

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The Treasury breakdown was both a symptom of and fuel to a larger drama playing out across markets. Investors seemed to be attempting to sell off entire portfolios, and they were struggling to do so. Commercial paper, the short-term debt companies use to fund themselves, was hard to renew. Investment-grade company bonds were difficult to trade, junk bonds all but impossible. Money market mutual funds, where companies and investors park their cash to make tiny returns, were seeing massive outflows. Financial publications reported that several hedge funds, including Capula and Bridgewater,[1] were sustaining heavy losses. Word had reached some employees at the New York Fed that several funds might be on the brink of collapse.

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Even after the Fed’s massive Sunday announcement, stock futures plunged before trading began, hitting the “limit down” trigger meant to stop irrational selling. When the actual market opened, it plummeted 8 percent immediately and tripped another “circuit breaker” intended to stop the downward spiral.[33] An array of corporations seemed likely to face a credit downgrade and investors were pulling money from funds that track junk bonds, the lowest-rated company debt. Investment trusts holding real estate bonds were tap-dancing on the brink of a meltdown, and though the Fed was buying some mortgage-backed debt, that was no cure-all.[34] The market for state and local bonds had ground to a complete standstill. New municipal bond issuances were being put on hold, raising questions about how public entities would raise the money they needed to pay the costs associated with the unfolding public health crisis.[35] Even as the Fed pledged to buy massive quantities of Treasury bonds, the market for government debt remained clogged.

How Money Became Dangerous by Christopher Varelas

activist fund / activist shareholder / activist investor, Airbnb, airport security, barriers to entry, basic income, Bear Stearns, Big Tech, bitcoin, blockchain, Bonfire of the Vanities, California gold rush, cashless society, corporate raider, crack epidemic, cryptocurrency, discounted cash flows, disintermediation, diversification, diversified portfolio, do well by doing good, Donald Trump, driverless car, dumpster diving, eat what you kill, fiat currency, financial engineering, fixed income, friendly fire, full employment, Gordon Gekko, greed is good, initial coin offering, interest rate derivative, John Meriwether, junk bonds, Kickstarter, Long Term Capital Management, low interest rates, mandatory minimum, Mary Meeker, Max Levchin, Michael Milken, mobile money, Modern Monetary Theory, mortgage debt, Neil Armstrong, pensions crisis, pets.com, pre–internet, profit motive, proprietary trading, risk tolerance, Saturday Night Live, selling pickaxes during a gold rush, shareholder value, side project, Silicon Valley, Steve Jobs, technology bubble, The Predators' Ball, too big to fail, universal basic income, zero day

That was the idea that Milken brought to Drexel and, through the 1970s, put into practice, forging an explosively powerful market around these high-yield bonds, commonly called junk bonds. Drexel became a major player on Wall Street, as Milken parlayed his junk bonds into supporting another booming market—mergers and acquisitions. His ability to access capital from the new market he created grew so deep and his connections so vast that he developed the ability to rapidly assemble armies of corporate raiders who could target any struggling company, no matter the size, backed by his junk bond war chest. That was how Saul Steinberg got the firepower to go after Disney. Drexel Burnham Lambert—which earned the nickname on Wall Street of Drain-’em Burn-’em & Lambast-’em—became the go-to investment bank and facilitator for these hostile takeovers on the strength of Milken’s high-yield bond market.

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The crowd set down their hot dogs and beers and applauded him warmly. After serving two years in prison on multiple felony convictions, he had reinvented himself as a philanthropist, and even his once infamous history as the Junk Bond King was now celebrated. Except that nowadays, no one says junk bond. The accepted term is high-yield bond. So Michael Milken is again a hero, junk bonds are high-yield bonds, and corporate raiders have become activist investors. This signals a major evolution in American business, from the time of Steinberg’s attack on Disney through to the current day. While these activist investors can certainly bring about positive results, one unfortunate consequence is that management teams have become laser-focused on the bottom line—and, in particular, the short-term bottom line—often at the expense of investing in and creating the best product three or five years from now.

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I’d been flirting with the idea that Michael Milken had possibly done more to revamp American business for the better than anyone by introducing a way to go after underperforming management. This forcing function—management being held accountable for profits—would make America competitive in the 1990s and beyond. Milken’s junk bonds later provided the financial vehicle for the rise of the telecom industry, the cable industry, and, one could argue, the technology world. Without junk bonds, none of these industries would have been created as swiftly and successfully as they were. “Milken is one of the most brilliant people I know,” Mark Albert told me years later. “Okay, he’s a convicted felon, but he changed the United States of America, and how people do business, by funding entrepreneurs and businesses that could not get traditional funding from banks, by creating markets that really didn’t exist, by creating the buy-side before he had the sell-side, since he knew there was always a sell-side.

The Money Machine: How the City Works by Philip Coggan

activist fund / activist shareholder / activist investor, algorithmic trading, asset-backed security, Bear Stearns, Bernie Madoff, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, bond market vigilante , bonus culture, Bretton Woods, call centre, capital controls, carried interest, central bank independence, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, disintermediation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, endowment effect, financial deregulation, financial independence, floating exchange rates, foreign exchange controls, Glass-Steagall Act, guns versus butter model, Hyman Minsky, index fund, intangible asset, interest rate swap, inverted yield curve, Isaac Newton, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", joint-stock company, junk bonds, labour market flexibility, large denomination, London Interbank Offered Rate, Long Term Capital Management, low interest rates, merger arbitrage, Michael Milken, money market fund, moral hazard, mortgage debt, negative equity, Nick Leeson, Northern Rock, pattern recognition, proprietary trading, purchasing power parity, quantitative easing, reserve currency, Right to Buy, Ronald Reagan, shareholder value, South Sea Bubble, sovereign wealth fund, technology bubble, time value of money, too big to fail, tulip mania, Washington Consensus, yield curve, zero-coupon bond

Later on, Milken played a key role in the takeover boom of the 1980s, financing predators with newly created ‘junk bonds’. These would trade at, or near, face value, but would offer much higher yields than other bonds in the market (to reflect the higher risk). The term junk bonds extended to cover all high-yielding bonds of this type. Milken fell from grace and was eventually jailed, and many investors who bought junk bonds at the peak of the market lost money. As with other financial theories, by attempting to exploit it so heavily, Milken and his followers altered the rules. If there was any merit to the junk bond theory, it was because few people bothered to follow the market and it was therefore possible to find bargains.

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The net result was that the reputation of the agencies undoubtedly suffered; perhaps they should have been more cautious in handing out their highest mark of approval. JUNK BONDS Bonds are generally seen as a conservative investment. They offer more security than equities, but a lower return. For much of the 1980s, however, a US phenomenon made the bond market seem positively exciting (in financial terms, at least); this was the enthusiasm for junk bonds. The term initially referred to bonds which had collapsed in price, normally because the company which issued them had become mired in financial difficulties.

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The market marked down the price of the bond because it feared the company would be unable to repay the capital, or even maintain the interest payments. In the language of the rating agencies (referred to above), the bonds would be ‘below investment grade’ with a rating below BBB. A smart trader called Michael Milken, who worked for a US banking group called Drexel Burnham Lambert, saw the opportunity for profit in junk bonds. Say a bond was issued with a coupon of 10 per cent, but the company gets into difficulty and its price falls to 50 (compared with a face value of 100). If the company just pays the interest, the investor will earn a running yield of 20 per cent (10/50). And if the company repays the bond in full, the investor will double his capital.

The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer

asset allocation, behavioural economics, book value, buy and hold, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial engineering, financial independence, financial innovation, high net worth, index fund, John Bogle, junk bonds, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, low interest rates, margin call, market bubble, mental accounting, money market fund, passive investing, Paul Samuelson, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, stocks for the long run, survivorship bias, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

Global fund: A mutual fund that invests in both U.S. and foreign securities Hedge fund: A fund used by wealthy individuals and institutions that is allowed to use risky strategies that are not available to mutual funds. High-yield bonds: See junk bonds. International fund: A mutual fund that invests in non-U.S. securities. Junk bonds (also known as high-yield bonds): Bonds with a credit rating of BB or lower, which indicates that the bonds are considered to be below investment grade. Companies that issue junk bonds promise to pay higher yields in order to attract buyers who otherwise might purchase safer bonds. Load fund: A mutual fund that levies a sales charge. Long-term capital gain: Profit on the sale of a security held at least one year that generally results in lower tax.

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By immediately buying or selling, these bond professionals almost instantly bring the bond's price back to perceived fair value. High-Yield Bonds High-yield bonds, also known as junk bonds, appeal to many investors because of their higher yields and sometimes higher returns than their more staid bond cousins. We have not included them in our portfolios for several reasons: 1. Bonds are primarily for safety. Stocks are primarily for higher return (and risk). Junk bond funds behave somewhere between traditional high-quality bonds and stocks. This tends to muddy the important distinction between bonds and stocks in a portfolio, thereby making risk control more difficult. 2.

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In addition, Standard & Poor's assigns bond ratings plusses (+) and minuses (-). A BBB- is the lowest of the investment grade bonds. Bonds with ratings lower than BBB- are considered speculative, and pay a higher interest rate since there's a greater risk that the issuing companies might not be able to repay investors. These lower-rated bonds are known as junk bonds, high yield bonds, and non-investment-grade bonds. Municipal Bonds State and local governments sell bonds to pay for various government and/or government-approved projects. These municipal bonds are normally free from federal taxation, and they are usually also free from taxes in the state of issue.

Americana: A 400-Year History of American Capitalism by Bhu Srinivasan

activist fund / activist shareholder / activist investor, American ideology, AOL-Time Warner, Apple II, Apple's 1984 Super Bowl advert, bank run, barriers to entry, Bear Stearns, Benchmark Capital, Berlin Wall, blue-collar work, Bob Noyce, Bonfire of the Vanities, British Empire, business cycle, buy and hold, California gold rush, Carl Icahn, Charles Lindbergh, collective bargaining, commoditize, Cornelius Vanderbilt, corporate raider, cotton gin, cuban missile crisis, Deng Xiaoping, diversification, diversified portfolio, Douglas Engelbart, Fairchild Semiconductor, financial innovation, fixed income, Ford Model T, Ford paid five dollars a day, global supply chain, Gordon Gekko, guns versus butter model, Haight Ashbury, hypertext link, Ida Tarbell, income inequality, information security, invisible hand, James Watt: steam engine, Jane Jacobs, Jeff Bezos, John Markoff, joint-stock company, joint-stock limited liability company, junk bonds, Kickstarter, laissez-faire capitalism, Louis Pasteur, Marc Andreessen, Menlo Park, Michael Milken, military-industrial complex, mortgage debt, mutually assured destruction, Norman Mailer, oil rush, peer-to-peer, pets.com, popular electronics, profit motive, punch-card reader, race to the bottom, refrigerator car, risk/return, Ronald Reagan, Sand Hill Road, self-driving car, shareholder value, side project, Silicon Valley, Silicon Valley startup, Steve Ballmer, Steve Jobs, Steve Wozniak, strikebreaker, Ted Nelson, The Death and Life of Great American Cities, the new new thing, The Predators' Ball, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, trade route, transcontinental railway, traveling salesman, Upton Sinclair, Vannevar Bush, Works Progress Administration, zero-sum game

Using little cash, assuming well over $1 billion in debt, and issuing additional junk bonds, Murdoch over the course of twelve months in 1985 bought Twentieth Century Fox in one transaction and followed up by buying seven local television stations from Metromedia. Supported by Milken’s operation, traders and bankers played multiple roles in financing Murdoch’s transactions and in creating the Fox brand on television to compete with CBS, NBC, and ABC. Similarly, the capital-intensive nature of cable, the next big thing within television, was an especially good fit for junk bond financing. Starting in the early eighties, American homes had rapidly started subscribing to pay television.

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With Milken’s capacity to raise virtually unlimited amounts of money by placing bonds with his loyal investors, what if Drexel could finance financial entrepreneurs with small companies or minor trading operations to buy giant American companies? It was an audacious strategy. With backing from Drexel, an investor that could afford to buy 5 or 10 percent of a company’s stock could now finance the other 90 or 95 percent by issuing junk bonds and acquire the entire company. The earnings of the company, or a partial sale of its assets, would then be used to pay the interest on the bonds. Junk bond financing was the equivalent of taking out a mortgage on a rental property and having the rent cover the mortgage payment, only instead of a rental property, the targets were companies like Revlon or Disney. The ability for insurgents like Icahn to leverage a small bit of capital and borrow a large amount set in motion years of high corporate drama, showdowns that featured old, established companies, with their pedigreed executives under assault by these upstarts financed by Milken and Drexel Burnham.

…

The rationale for the business model was that private ownership would bring an unwieldy public company needed operating discipline. The new owners, with huge junk bond debt loads, had to cut frivolous expenses to pay the interest. In this telling, debt was a great disciplinarian. Yet the logic contained an irony: It suggested that large, for-profit, publicly traded companies, despite the forces of free-market capitalism, could be highly inefficient and wasteful if left to their own devices. By the end of the 1980s, KKR would successfully complete the largest leveraged buyout in American corporate history. Using junk bonds, it would buy the tobacco and snack maker RJR Nabisco for nearly $25 billion.

Americana by Bhu Srinivasan

activist fund / activist shareholder / activist investor, American ideology, AOL-Time Warner, Apple II, Apple's 1984 Super Bowl advert, bank run, barriers to entry, Bear Stearns, Benchmark Capital, Berlin Wall, blue-collar work, Bob Noyce, Bonfire of the Vanities, British Empire, business cycle, buy and hold, California gold rush, Carl Icahn, Charles Lindbergh, collective bargaining, commoditize, Cornelius Vanderbilt, corporate raider, cotton gin, cuban missile crisis, Deng Xiaoping, diversification, diversified portfolio, Douglas Engelbart, Fairchild Semiconductor, financial innovation, fixed income, Ford Model T, Ford paid five dollars a day, global supply chain, Gordon Gekko, guns versus butter model, Haight Ashbury, hypertext link, Ida Tarbell, income inequality, information security, invisible hand, James Watt: steam engine, Jane Jacobs, Jeff Bezos, John Markoff, joint-stock company, joint-stock limited liability company, junk bonds, Kickstarter, laissez-faire capitalism, Louis Pasteur, Marc Andreessen, Menlo Park, Michael Milken, military-industrial complex, mortgage debt, mutually assured destruction, Norman Mailer, oil rush, peer-to-peer, pets.com, popular electronics, profit motive, punch-card reader, race to the bottom, refrigerator car, risk/return, Ronald Reagan, Sand Hill Road, self-driving car, shareholder value, side project, Silicon Valley, Silicon Valley startup, Steve Ballmer, Steve Jobs, Steve Wozniak, strikebreaker, Ted Nelson, The Death and Life of Great American Cities, the new new thing, The Predators' Ball, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, trade route, transcontinental railway, traveling salesman, Upton Sinclair, Vannevar Bush, Works Progress Administration, zero-sum game

Using little cash, assuming well over $1 billion in debt, and issuing additional junk bonds, Murdoch over the course of twelve months in 1985 bought Twentieth Century Fox in one transaction and followed up by buying seven local television stations from Metromedia. Supported by Milken’s operation, traders and bankers played multiple roles in financing Murdoch’s transactions and in creating the Fox brand on television to compete with CBS, NBC, and ABC. Similarly, the capital-intensive nature of cable, the next big thing within television, was an especially good fit for junk bond financing. Starting in the early eighties, American homes had rapidly started subscribing to pay television.

…

With Milken’s capacity to raise virtually unlimited amounts of money by placing bonds with his loyal investors, what if Drexel could finance financial entrepreneurs with small companies or minor trading operations to buy giant American companies? It was an audacious strategy. With backing from Drexel, an investor that could afford to buy 5 or 10 percent of a company’s stock could now finance the other 90 or 95 percent by issuing junk bonds and acquire the entire company. The earnings of the company, or a partial sale of its assets, would then be used to pay the interest on the bonds. Junk bond financing was the equivalent of taking out a mortgage on a rental property and having the rent cover the mortgage payment, only instead of a rental property, the targets were companies like Revlon or Disney. The ability for insurgents like Icahn to leverage a small bit of capital and borrow a large amount set in motion years of high corporate drama, showdowns that featured old, established companies, with their pedigreed executives under assault by these upstarts financed by Milken and Drexel Burnham.

…

The rationale for the business model was that private ownership would bring an unwieldy public company needed operating discipline. The new owners, with huge junk bond debt loads, had to cut frivolous expenses to pay the interest. In this telling, debt was a great disciplinarian. Yet the logic contained an irony: It suggested that large, for-profit, publicly traded companies, despite the forces of free-market capitalism, could be highly inefficient and wasteful if left to their own devices. By the end of the 1980s, KKR would successfully complete the largest leveraged buyout in American corporate history. Using junk bonds, it would buy the tobacco and snack maker RJR Nabisco for nearly $25 billion.

The Price of Time: The Real Story of Interest by Edward Chancellor

"World Economic Forum" Davos, 3D printing, activist fund / activist shareholder / activist investor, Airbnb, Alan Greenspan, asset allocation, asset-backed security, assortative mating, autonomous vehicles, balance sheet recession, bank run, banking crisis, barriers to entry, Basel III, Bear Stearns, Ben Bernanke: helicopter money, Bernie Sanders, Big Tech, bitcoin, blockchain, bond market vigilante , bonus culture, book value, Bretton Woods, BRICs, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, cashless society, cloud computing, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, commodity super cycle, computer age, coronavirus, corporate governance, COVID-19, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cryptocurrency, currency peg, currency risk, David Graeber, debt deflation, deglobalization, delayed gratification, Deng Xiaoping, Detroit bankruptcy, distributed ledger, diversified portfolio, Dogecoin, Donald Trump, double entry bookkeeping, Elon Musk, equity risk premium, Ethereum, ethereum blockchain, eurozone crisis, everywhere but in the productivity statistics, Extinction Rebellion, fiat currency, financial engineering, financial innovation, financial intermediation, financial repression, fixed income, Flash crash, forward guidance, full employment, gig economy, Gini coefficient, Glass-Steagall Act, global reserve currency, global supply chain, Goodhart's law, Great Leap Forward, green new deal, Greenspan put, high net worth, high-speed rail, housing crisis, Hyman Minsky, implied volatility, income inequality, income per capita, inflation targeting, initial coin offering, intangible asset, Internet of things, inventory management, invisible hand, Japanese asset price bubble, Jean Tirole, Jeff Bezos, joint-stock company, Joseph Schumpeter, junk bonds, Kenneth Rogoff, land bank, large denomination, Les Trente Glorieuses, liquidity trap, lockdown, Long Term Capital Management, low interest rates, Lyft, manufacturing employment, margin call, Mark Spitznagel, market bubble, market clearing, market fundamentalism, Martin Wolf, mega-rich, megaproject, meme stock, Michael Milken, Minsky moment, Modern Monetary Theory, Mohammed Bouazizi, Money creation, money market fund, moral hazard, mortgage debt, negative equity, new economy, Northern Rock, offshore financial centre, operational security, Panopticon Jeremy Bentham, Paul Samuelson, payday loans, peer-to-peer lending, pensions crisis, Peter Thiel, Philip Mirowski, plutocrats, Ponzi scheme, price mechanism, price stability, quantitative easing, railway mania, reality distortion field, regulatory arbitrage, rent-seeking, reserve currency, ride hailing / ride sharing, risk free rate, risk tolerance, risk/return, road to serfdom, Robert Gordon, Robinhood: mobile stock trading app, Satoshi Nakamoto, Satyajit Das, Savings and loan crisis, savings glut, Second Machine Age, secular stagnation, self-driving car, shareholder value, Silicon Valley, Silicon Valley startup, South Sea Bubble, Stanford marshmallow experiment, Steve Jobs, stock buybacks, subprime mortgage crisis, Suez canal 1869, tech billionaire, The Great Moderation, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Thorstein Veblen, Tim Haywood, time value of money, too big to fail, total factor productivity, trickle-down economics, tulip mania, Tyler Cowen, Uber and Lyft, Uber for X, uber lyft, Walter Mischel, WeWork, When a measure becomes a target, yield curve

At the same time, ‘The Fed became possibly the biggest carry trader of all: its balance sheet is a huge carry trade with large holdings of yielding securities, such as Treasury securities and mortgage-backed securities, financed by very low-cost liabilities.’10 Central banking in the age of quantitative easing proved an extremely lucrative business. In 2015, the Fed earned profits of nearly $100 billion on its securities portfolio, which was financed by printing dollars. JUNK BONDS AND LEVERAGED LOANS One consequence of the return of yield-chasing was a dramatic collapse in underwriting standards. After Lehman’s bankruptcy, US junk bond yields soared to more than 20 percentage points above Treasuries. But thanks to the Fed’s prompt actions, the expected tsunami of corporate bankruptcies never arrived. Instead, credit spreads contracted, and the high-yield market reopened.

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Henry Kravis, the veteran founder of the leading buyout firm KKR, boasted that his firm’s acquisition of Del Monte Foods in March 2011 was completed with ‘the most attractive financing that we’ve ever done’.11 Credit quality collapsed as more of the lowest-rated bonds (CCC) came to the market.12 The world’s leading authority on distressed debt, Professor Edward Altman of New York University, attributed the incipient credit bubble to an ‘insatiable appetite for higher yields in this low-interest rate environment’.13 The playbook was eerily familiar, as a 2015 report from Ellington Capital Management observed: These same hallmarks of the subprime mortgage bubble – outsized lending to riskier borrowers, record low interest rates, dubious underwriting practices and collateral valuation assumptions, misalignment of incentives between managers and investors, and weakening fundamentals – are all present today in high yield corporate debt markets. The difference today is that the Fed has been trying to revive the economy with zero interest rates for the past seven years.fn3 Like junk bonds, leveraged loans are issued by companies with poor credit ratings and are often issued to finance buyout deals. Unlike junk bonds, they pay floating rather than fixed rates. As underwriting standards declined, the leveraged loan market became dominated by so-called ‘covenant-lite’ issues, which came without the protections traditionally afforded creditors, such as limits on taking on more debt.

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By 2016, the Organisation for Economic Co-operation and Development found that 10 per cent of firms were unable to cover their interest payments from profits – the OECD’s definition of a zombie. Europe, it seemed, was turning Japanese. The zombie phenomenon was not confined to continental Europe. In both the United States and United Kingdom, ultra-low rates forestalled corporate bankruptcies. The default rate on US junk bonds after the Great Recession was just half the average of the two previous downturns. ‘The Fed’s extraordinary intervention,’ credit analyst Martin Fridson suggested, ‘enabled companies [to survive] that should have failed.’21 In Britain, the insolvency rate was also lower in the 2008–9 recession than during the milder economic downturn of the early 1990s.

Lessons from the Titans: What Companies in the New Economy Can Learn from the Great Industrial Giants to Drive Sustainable Success by Scott Davis, Carter Copeland, Rob Wertheimer

3D printing, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, airport security, asset light, barriers to entry, Big Tech, Boeing 747, business cycle, business process, clean water, commoditize, coronavirus, corporate governance, COVID-19, data science, disruptive innovation, Elisha Otis, Elon Musk, factory automation, fail fast, financial engineering, Ford Model T, global pandemic, hydraulic fracturing, Internet of things, iterative process, junk bonds, Kaizen: continuous improvement, Kanban, low cost airline, Marc Andreessen, Mary Meeker, megacity, Michael Milken, Network effects, new economy, Ponzi scheme, profit maximization, random walk, RFID, ride hailing / ride sharing, risk tolerance, Salesforce, shareholder value, Silicon Valley, six sigma, skunkworks, software is eating the world, strikebreaker, tech billionaire, TED Talk, Toyota Production System, Uber for X, value engineering, warehouse automation, WeWork, winner-take-all economy

With the unexpected success at Jacobs, the Raleses aimed for bigger acquisitions where Lean could be applied. But banks were naturally risk averse, and debt markets on Wall Street were still emerging, which brought Danaher into the world of junk bonds. After an introductory meeting with junk bond king Michael Milken, the Danaher team decided that junk bonds would supply the next stage of growth. In the late 1980s, junk bonds fueled both growth successes and debt excesses—and Milken was the gatekeeper. Companies now had a new tool to fund aggressive plans. Investors rushed to the higher yields provided. History shines a negative light on this era, but like anything else, there was both good and bad.

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History shines a negative light on this era, but like anything else, there was both good and bad. While Danaher insiders credit the company’s shrewd acquisitions and Lean manufacturing for its success today, most also say that junk bonds enabled the company to grow much faster than it otherwise would have at this crucial stage. In the late 1980s industrial assets were for sale on the cheap, but banks viewed these acquisitions as very risky. Even though junk bonds had high coupon debt levels, the returns on the deals were proportionally much higher. This new market fit Danaher’s early needs perfectly. In those early years, Danaher acquired businesses considered solid, yet poorly run and in need of very hands-on management support.

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That one had a whopping $20 billion price tag that takes Danaher deeper into the high-growth biotechnology space. The debate about Joyce’s ultimate success remains open for sure. But so far, the growth rate and execution of deals seem to support the higher acquisition prices he paid, all of which have been fueled by lower interest rates overall. In Danaher’s junk bond days, it would commonly pay 10 percent to finance a deal on which it hoped to earn a minimum of 15 percent. In today’s world, financing costs often fall below 3 percent, so to get the same investment impact, the return wouldn’t have to be much more than 8 percent. On the GE Biopharma deal, Danaher was able to finance the debt at sub 1 percent—an unprecedented funding cost level.

The Last Tycoons: The Secret History of Lazard Frères & Co. by William D. Cohan

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", activist fund / activist shareholder / activist investor, Alan Greenspan, AOL-Time Warner, bank run, Bear Stearns, book value, Carl Icahn, carried interest, cognitive dissonance, commoditize, computer age, corporate governance, corporate raider, creative destruction, credit crunch, deal flow, diversification, Donald Trump, East Village, fear of failure, financial engineering, fixed income, G4S, Glass-Steagall Act, hiring and firing, interest rate swap, intermodal, Joseph Schumpeter, junk bonds, land bank, late fees, Long Term Capital Management, Marc Andreessen, market bubble, Michael Milken, offshore financial centre, Ponzi scheme, proprietary trading, Ralph Nader, Ralph Waldo Emerson, rolodex, Ronald Reagan, shareholder value, short squeeze, SoftBank, stock buybacks, The Nature of the Firm, the new new thing, Yogi Berra

He alone can claim to have advised corporate executives on transformational deals in each of the last five decades across disparate industries. One could argue, quite rightly, that Felix invented the persona of investment banker as trusted corporate M&A adviser. Although he might find the comparison indelicate because he abhorred junk bonds, in the 1960s Felix divined the business of providing independent M&A advice to corporate chieftains in much the same way as the infamous Michael Milken conjured up the high-yield junk-bond market in the 1980s. In an utterly typical week in January 1969, for instance, Felix had many meetings, including those with Howmet, a French aerospace company where he was on the board of directors, and with Harold Geneen (CEO of ITT), Nicholas Brady (then a banker at Dillon Read and later the U.S.

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Moody's didn't help Lazard's cause when it rated the debt Lazard would be issuing as Ba1, below investment grade. And then Duff & Phelps, another rating agency, gave the Lazard debt an unsolicited and unexpected below investment grade rating as well, giving the debt offerings the whiff of a junk-bond offering--itself utterly ironic given all of Felix's railings against the junk-bond market. Pricing pressure on the debt put pricing pressure on the equity. Two days before the deal was to price, the high-profile professional stock picker and ranter Jim Cramer urged investors to stay away. "How awful is this Lazard IPO deal?" he wondered on his Web site (as opposed to in his financial column in Bruce's New York).

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He often described Lazard as simply "a group of important people, giving important people advice." Felix was proud to be solely an adviser whose wisdom was sought out internationally for cogent, insightful advice on mergers and acquisitions: nothing more, nothing less--and not a trace of apology for not being the top underwriter of junk bonds (a product he railed against) or equity offerings. No frustration with not being a private-equity investor. The Big Boys, a 1986 book by Ralph Nader and William Taylor, referred to Felix as "the interstitial man," someone who gets in the middle of things. Raymond Troubh, a former Lazard partner, was one of many people quoted by Nader and Taylor about Felix.

The Snowball: Warren Buffett and the Business of Life by Alice Schroeder

affirmative action, Alan Greenspan, Albert Einstein, anti-communist, AOL-Time Warner, Ayatollah Khomeini, barriers to entry, Bear Stearns, Black Monday: stock market crash in 1987, Bob Noyce, Bonfire of the Vanities, book value, Brownian motion, capital asset pricing model, card file, centralized clearinghouse, Charles Lindbergh, collateralized debt obligation, computerized trading, Cornelius Vanderbilt, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, do what you love, Donald Trump, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, Fairchild Semiconductor, Fillmore Auditorium, San Francisco, financial engineering, Ford Model T, Garrett Hardin, Glass-Steagall Act, global village, Golden Gate Park, Greenspan put, Haight Ashbury, haute cuisine, Honoré de Balzac, If something cannot go on forever, it will stop - Herbert Stein's Law, In Cold Blood by Truman Capote, index fund, indoor plumbing, intangible asset, interest rate swap, invisible hand, Isaac Newton, it's over 9,000, Jeff Bezos, John Bogle, John Meriwether, joint-stock company, joint-stock limited liability company, junk bonds, Larry Ellison, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, market bubble, Marshall McLuhan, medical malpractice, merger arbitrage, Michael Milken, Mikhail Gorbachev, military-industrial complex, money market fund, moral hazard, NetJets, new economy, New Journalism, North Sea oil, paper trading, passive investing, Paul Samuelson, pets.com, Plato's cave, plutocrats, Ponzi scheme, proprietary trading, Ralph Nader, random walk, Ronald Reagan, Salesforce, Scientific racism, shareholder value, short selling, side project, Silicon Valley, Steve Ballmer, Steve Jobs, supply-chain management, telemarketer, The Predators' Ball, The Wealth of Nations by Adam Smith, Thomas Malthus, tontine, too big to fail, Tragedy of the Commons, transcontinental railway, two and twenty, Upton Sinclair, War on Poverty, Works Progress Administration, Y2K, yellow journalism, zero-coupon bond

4 In 1984, the burner under managements turned up another notch when “junk bonds” became respectable. More politely called “fallen angels,” these were the bonds of companies like the Penn Central Railroad that were climbing out of the bankruptcy dustbin or teetering on its edge.5 Only occasionally did a company issue junk bonds on purpose, paying a high interest rate because it was considered a dicey credit risk. Junk bonds were sort of shady, a little desperate. The people who worked in the junk-bond departments on Wall Street were junk peddlers or ragpickers—the few bankers who scouted for hag-ridden executives willing to issue junk bonds, and “distressed debt” analysts who spent their careers grading papers in the gloomy school of hard knocks, looking over picked-clean balance sheets and scuttlebutting bankruptcy lawyers, angry investors, and desperate managements.

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Everything changed when Michael Milken, chief junk peddler of the upstart investment bank Drexel Burnham Lambert, rose to become the most influential man on Wall Street through a simple proposition: that while individual “fallen angel” junk bonds were risky, buying a bushel of them was not, because on average, the higher interest rate more than compensated for the risk. In other words, junk bonds in the aggregate had a margin of safety—like cigar butts. Soon, money managers no longer looked as though they were playing roulette with investors’ money by putting high-paying junk bonds in their portfolios. Indeed, it quickly became more respectable to issue new junk bonds—quite a different thing. Another short hop and takeovers of strong, well-financed companies could be financed with junk, turning formerly sound balance sheets into debt-riddled Swiss cheese.

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But to make big money on arbitrage—buying and selling two nearly identical things to profit from their difference in price—required scaffoldings of debt, in which more and more assets were sold short to buy more and more assets on the “long” side.48 This expansion of leverage from hedge funds and arbitrage was related to the rise of junk bonds and takeovers occurring at the same time. The models that supported the argument for leveraged buyouts using junk bonds were, like the models used by arbitrageurs, variations of the efficient-market hypothesis. Leverage, however, was like gasoline. In a rising market, a car used more of it to go faster. In a crash, it was what made the car blow up. This is why Buffett and Munger considered defining risk as volatility to be “twaddle and bullshit,” as Munger would later put it.

Evil Geniuses: The Unmaking of America: A Recent History by Kurt Andersen

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, affirmative action, Affordable Care Act / Obamacare, air traffic controllers' union, airline deregulation, airport security, Alan Greenspan, always be closing, American ideology, American Legislative Exchange Council, An Inconvenient Truth, anti-communist, Apple's 1984 Super Bowl advert, artificial general intelligence, autonomous vehicles, basic income, Bear Stearns, Bernie Sanders, blue-collar work, Bonfire of the Vanities, bonus culture, Burning Man, call centre, Capital in the Twenty-First Century by Thomas Piketty, carbon tax, Cass Sunstein, centre right, computer age, contact tracing, coronavirus, corporate governance, corporate raider, cotton gin, COVID-19, creative destruction, Credit Default Swap, cryptocurrency, deep learning, DeepMind, deindustrialization, Donald Trump, Dr. Strangelove, Elon Musk, ending welfare as we know it, Erik Brynjolfsson, feminist movement, financial deregulation, financial innovation, Francis Fukuyama: the end of history, future of work, Future Shock, game design, General Motors Futurama, George Floyd, George Gilder, Gordon Gekko, greed is good, Herbert Marcuse, Herman Kahn, High speed trading, hive mind, income inequality, industrial robot, interchangeable parts, invisible hand, Isaac Newton, It's morning again in America, James Watt: steam engine, Jane Jacobs, Jaron Lanier, Jeff Bezos, jitney, Joan Didion, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Joseph Schumpeter, junk bonds, Kevin Roose, knowledge worker, lockdown, low skilled workers, Lyft, Mark Zuckerberg, market bubble, mass immigration, mass incarceration, Menlo Park, Naomi Klein, new economy, Norbert Wiener, Norman Mailer, obamacare, Overton Window, Peter Thiel, Picturephone, plutocrats, post-industrial society, Powell Memorandum, pre–internet, public intellectual, Ralph Nader, Right to Buy, road to serfdom, Robert Bork, Robert Gordon, Robert Mercer, Ronald Reagan, Saturday Night Live, Seaside, Florida, Second Machine Age, shareholder value, Silicon Valley, social distancing, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, Stewart Brand, stock buybacks, strikebreaker, tech billionaire, The Death and Life of Great American Cities, The Future of Employment, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Tim Cook: Apple, too big to fail, trickle-down economics, Tyler Cowen, Tyler Cowen: Great Stagnation, Uber and Lyft, uber lyft, union organizing, universal basic income, Unsafe at Any Speed, urban planning, urban renewal, very high income, wage slave, Wall-E, War on Poverty, We are all Keynesians now, Whole Earth Catalog, winner-take-all economy, women in the workforce, working poor, young professional, éminence grise

But most important to making the formerly disreputable LBO take off was a new way to finance the takeovers—by means of the formerly disreputable junk bond. Junk bonds had been what happened to good bonds when the issuing corporations got into trouble, causing the big rating firms to downgrade the bonds, which meant the corporations had to pay higher interest to people who bought their bonds. But then in the late 1970s, the young Los Angeles investment banker Mike Milken started creating and issuing risky bonds as junk bonds, from scratch, thereby creating a white-hot new financial subindustry.*3 During just the first half of the 1980s, the market for junk bonds grew sixfold, to the equivalent of $94 billion a year, and more than a thousand different junk bonds were issued—half of which wound up defaulting, failing to pay the money due when it was due to the bond owners.

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.*3 During just the first half of the 1980s, the market for junk bonds grew sixfold, to the equivalent of $94 billion a year, and more than a thousand different junk bonds were issued—half of which wound up defaulting, failing to pay the money due when it was due to the bond owners. Junk bonds are like car manufacturers deciding to start making and marketing lines of brand-new designated lemons—cheaper parts, shoddily manufactured, much more liable to break down or crash, but so inexpensive. Funded with junk bonds or not, a typical LBO was a conceptually new sort of acquisition, more brazen and shameless in its selfishness and greed—indifferent outsiders offering to make a few executive collaborators very rich as long as they were up for abandoning their fellow employees and the company itself if necessary.

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Most people agree that short-term thinking has become a chronic problem for business, for the economy, for society—yet unabashed short-termism is the point of an LBO, the financiers’ optimal outcome being to take over, make a fortune, and disappear as quickly as they can. One of the godfathers of this fast-and-loose new game was Henry Kravis, whose Manhattan firm Kohlberg Kravis Roberts got the craze going in 1979 by investing a cash down payment equivalent to $4 million to use $1 billion in junk bonds and other debt to take over an obscure Fortune 500 company. One of the most spectacular early LBOs was undertaken by former treasury secretary William Simon after he left government to propagandize for the right and the rich, and to get very rich. (By his account, he was still in public service—because, as he’d testified to a Senate committee, “If you really want to help the poor, help the rich.”)

Wall Street Meat by Andy Kessler

accounting loophole / creative accounting, Alan Greenspan, Andy Kessler, automated trading system, banking crisis, Bob Noyce, George Gilder, index fund, Jeff Bezos, John Bogle, junk bonds, market bubble, Mary Meeker, Menlo Park, Michael Milken, Pepto Bismol, pets.com, Robert Metcalfe, rolodex, Salesforce, Sand Hill Road, Silicon Valley, Small Order Execution System, Steve Jobs, technology bubble, undersea cable, Y2K

Almost everyone at Morgan Stanley was convinced that I was a worthless buffoon. Then, in October of 1989, the strangest thing happened. United Airlines was trying to go private, in a huge, employeeled leverage buyout, but the deal started to unravel. Just like that. Junk bond buyers refused to play, somehow assessing the risk to be too great. The junk bond market collapsed, all in one day. The Dow dropped 190 points, and everyone at Morgan Stanley, myself included, fell into a deep mental depression. This was a mini-crash, but it reminded everyone of the real crash two years earlier. That day, for some strange reason, Rod Berens bought a case of champagne and threw a party in the hallway of the research department to celebrate.

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It wasn’t the rip-roaring bull market that would show up in 1987, but things were hopping. All of New York caught stock fever. Still, it wasn’t so easy. No matter how good a call you had, most of the stocks that were working were takeovers, leveraged buyouts and companies put in play by Drexel Burnham and its junk bond king, Michael Milken. I heard about these guys every day. The rest of the street was in awe. One day, I was walking down 5th Avenue with one of our salesmen and his client, when the salesman asked why the account didn’t do more business with us. The client was brutally honest. “Who needs you? I get a call every morning from my Drexel salesman who tells me the next set of companies that are going to be in play.

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Leveraged buyouts, LBOs, were all the rage. Junk 103 Wall Street Meat bonds, despite the bad name they got leading up to the ’87 crash, were plentiful. Salomon, Goldman, Merrill and even Morgan Stanley had taken share from Drexel Burnham peddling high-yield bonds to whoever could use them. Technology companies couldn’t use these junk bonds. Research and development to advance technology cost too much, and either you pay interest or you fund R&D. Anyone back on R&D would be dead within 18 months. Of course, I was still new to Morgan Stanley as an analyst. For months, I was pounding the table recommending Intel’s stock, but the stock just went sideways.

Principles of Corporate Finance by Richard A. Brealey, Stewart C. Myers, Franklin Allen

3Com Palm IPO, accelerated depreciation, accounting loophole / creative accounting, Airbus A320, Alan Greenspan, AOL-Time Warner, Asian financial crisis, asset allocation, asset-backed security, banking crisis, Bear Stearns, Bernie Madoff, big-box store, Black Monday: stock market crash in 1987, Black-Scholes formula, Boeing 747, book value, break the buck, Brownian motion, business cycle, buy and hold, buy low sell high, California energy crisis, capital asset pricing model, capital controls, Carl Icahn, Carmen Reinhart, carried interest, collateralized debt obligation, compound rate of return, computerized trading, conceptual framework, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-border payments, cross-subsidies, currency risk, discounted cash flows, disintermediation, diversified portfolio, Dutch auction, equity premium, equity risk premium, eurozone crisis, fear index, financial engineering, financial innovation, financial intermediation, fixed income, frictionless, fudge factor, German hyperinflation, implied volatility, index fund, information asymmetry, intangible asset, interest rate swap, inventory management, Iridium satellite, James Webb Space Telescope, junk bonds, Kenneth Rogoff, Larry Ellison, law of one price, linear programming, Livingstone, I presume, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, low interest rates, market bubble, market friction, money market fund, moral hazard, Myron Scholes, new economy, Nick Leeson, Northern Rock, offshore financial centre, PalmPilot, Ponzi scheme, prediction markets, price discrimination, principal–agent problem, profit maximization, purchasing power parity, QR code, quantitative trading / quantitative finance, random walk, Real Time Gross Settlement, risk free rate, risk tolerance, risk/return, Robert Shiller, Scaled Composites, shareholder value, Sharpe ratio, short selling, short squeeze, Silicon Valley, Skype, SpaceShipOne, Steve Jobs, subprime mortgage crisis, sunk-cost fallacy, systematic bias, Tax Reform Act of 1986, The Nature of the Firm, the payments system, the rule of 72, time value of money, too big to fail, transaction costs, University of East Anglia, urban renewal, VA Linux, value at risk, Vanguard fund, vertical integration, yield curve, zero-coupon bond, zero-sum game, Zipcar

Bonds rated Baa or above are known as investment-grade bonds.19 Commercial banks, many pension funds, and other financial institutions are not allowed to invest in bonds unless they are investment-grade.20 Bonds rated below Baa are termed high-yield, or junk, bonds. Most junk bonds used to be fallen angels, that is, bonds of companies that had fallen on hard times. But during the 1980s new issues of junk bonds multiplied tenfold as more and more companies issued large quantities of low-grade debt to finance takeovers. The result was that for the first time corporate midgets were able to take control of corporate giants. TABLE 23.1 Key to bond ratings. The highest-quality bonds are rated triple-A. Investment-grade bonds have to be the equivalent of Baa or higher. Bonds that don’t make this cut are called “high-yield” or “junk” bonds. Issuers of these junk bonds often had debt ratios of 90% to 95%.

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LBOs are almost by definition diet deals. But there were other motives. Here are some of them. The Junk Bond Markets LBOs and debt-financed takeovers may have been driven by artificially cheap funding from the junk bond markets. With hindsight, it seems that investors underestimated the risks of default in junk bonds. Default rates climbed painfully, reaching 10.3% in 1991.5 The market also became temporarily much less liquid after the demise in 1990 of Drexel Burnham, the investment banking firm that was the chief market maker in junk bonds. Leverage and Taxes Borrowing money saves taxes, as we explained in Chapter 18.

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At the bottom of the heap are high-yield or “junk” bonds. There is considerable variation in the yield spreads on junk bonds; a typical spread might be about 5% over Treasuries, but, as we saw in the case of the LifeCare bond, spreads can go skyward as companies approach distress. Remember these are promised yields and companies don’t always keep their promises. Many high-yielding bonds have defaulted, while some of the more successful issuers have called their debt, thus depriving their holders of the prospect of a continuing stream of high coupon payments. So while the promised yield on junk bonds has averaged 5% more than yields on Treasuries, the annual return since 1980 has been less than 3% higher.

The Blockchain Alternative: Rethinking Macroeconomic Policy and Economic Theory by Kariappa Bheemaiah

"World Economic Forum" Davos, accounting loophole / creative accounting, Ada Lovelace, Adam Curtis, Airbnb, Alan Greenspan, algorithmic trading, asset allocation, autonomous vehicles, balance sheet recession, bank run, banks create money, Basel III, basic income, behavioural economics, Ben Bernanke: helicopter money, bitcoin, Bletchley Park, blockchain, Bretton Woods, Brexit referendum, business cycle, business process, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, cashless society, cellular automata, central bank independence, Charles Babbage, Claude Shannon: information theory, cloud computing, cognitive dissonance, collateralized debt obligation, commoditize, complexity theory, constrained optimization, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-border payments, crowdsourcing, cryptocurrency, data science, David Graeber, deep learning, deskilling, Diane Coyle, discrete time, disruptive innovation, distributed ledger, diversification, double entry bookkeeping, Ethereum, ethereum blockchain, fiat currency, financial engineering, financial innovation, financial intermediation, Flash crash, floating exchange rates, Fractional reserve banking, full employment, George Akerlof, Glass-Steagall Act, Higgs boson, illegal immigration, income inequality, income per capita, inflation targeting, information asymmetry, interest rate derivative, inventory management, invisible hand, John Maynard Keynes: technological unemployment, John von Neumann, joint-stock company, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, knowledge economy, large denomination, Large Hadron Collider, Lewis Mumford, liquidity trap, London Whale, low interest rates, low skilled workers, M-Pesa, machine readable, Marc Andreessen, market bubble, market fundamentalism, Mexican peso crisis / tequila crisis, Michael Milken, MITM: man-in-the-middle, Money creation, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, natural language processing, Network effects, new economy, Nikolai Kondratiev, offshore financial centre, packet switching, Pareto efficiency, pattern recognition, peer-to-peer lending, Ponzi scheme, power law, precariat, pre–internet, price mechanism, price stability, private sector deleveraging, profit maximization, QR code, quantitative easing, quantitative trading / quantitative finance, Ray Kurzweil, Real Time Gross Settlement, rent control, rent-seeking, robo advisor, Satoshi Nakamoto, Satyajit Das, Savings and loan crisis, savings glut, seigniorage, seminal paper, Silicon Valley, Skype, smart contracts, software as a service, software is eating the world, speech recognition, statistical model, Stephen Hawking, Stuart Kauffman, supply-chain management, technology bubble, The Chicago School, The Future of Employment, The Great Moderation, the market place, The Nature of the Firm, the payments system, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, trade liberalization, transaction costs, Turing machine, Turing test, universal basic income, Vitalik Buterin, Von Neumann architecture, Washington Consensus

While this itself was revolutionary in the eighties, the real transformation of these high yield bonds was that now outsiders from the financial system were given access to capital that was previously denied to them by traditional banks. Capital in the past was in the hands of the great American industrial families. But with high yield bonds, capital was democratized and no longer the property of a small group. An increasing number of new entrepreneurs who invested in junk bonds became wealthy, which brought in new investors who were eager to purchase these junk bonds. In essence it became a tool to challenge the established power on Wall Street as it began to be implemented in the form of takeovers. One of the first policies passed by Reagan relaxed the rules that governed the takeover of companies. Milken realised that the passing of this policy could allow his high yield bonds to raise large sums of money, as although there was high amount of risk involved, hidden away in established corporations were assets that could be unlocked, sold off, and turned into fantastic profits for investors (Curtis and Hobley, 1999).

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While it is beyond the scope of this book to analyze this subject in detail, a short note must be dedicated to it, as tracing the history of today’s debt-ridden culture is as important as finding a solution to it. Sidebar 1-1 summarizes a series of events that offer some insight into how we got to where we are today. Sidebar 1-1: Junk Bonds and Reaganomics The trend in increasing indebtedness of households and companies can partly be traced to the energy crises of the ’70s. As the oil embargo of 1973 tumbled with the outbreak of the Iran-Iraq war in 1980, it led to massive increases in the price of oil and caused economic and social chaos in the developed industrialized world.

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His strategy was thus to take away economic decision-making powers from the government and hand it to the financial markets and Wall Street. Unsurprisingly, this became a moment of opportunity for most Wall Street bankers. One of the bankers who leapt at this opportunity was Michael Milken, the future founder of the Milken Institute. Milken had invented a debt instrument called high-yield bonds (which the established banks called junk bonds ) which he had used as a way to raise vast sums to build casinos in Las Vegas. Casinos were a business most banks avoided, as they were too risky. But Milken was able to show that as the risk involved with these investments was higher, it allowed investors to demand a very high rate of return. Even if some of the business did go bust, by investing across a large spread of these companies, on average, the investor stood to gain a fortune.

The Quants by Scott Patterson

Alan Greenspan, Albert Einstein, AOL-Time Warner, asset allocation, automated trading system, Bear Stearns, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Monday: stock market crash in 1987, Black Swan, Black-Scholes formula, Blythe Masters, Bonfire of the Vanities, book value, Brownian motion, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, Carl Icahn, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Dr. Strangelove, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial engineering, Financial Modelers Manifesto, fixed income, Glass-Steagall Act, global macro, Gordon Gekko, greed is good, Haight Ashbury, I will remember that I didn’t make the world, and it doesn’t satisfy my equations, index fund, invention of the telegraph, invisible hand, Isaac Newton, Jim Simons, job automation, John Meriwether, John Nash: game theory, junk bonds, Kickstarter, law of one price, Long Term Capital Management, Louis Bachelier, low interest rates, mandelbrot fractal, margin call, Mark Spitznagel, merger arbitrage, Michael Milken, military-industrial complex, money market fund, Myron Scholes, NetJets, new economy, offshore financial centre, old-boy network, Paul Lévy, Paul Samuelson, Ponzi scheme, proprietary trading, quantitative hedge fund, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Robert Mercer, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Savings and loan crisis, Sergey Aleynikov, short selling, short squeeze, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise

Quants were agnostic on such matters, devoting themselves instead to predicting whether a company’s stock would move up or down based on a dizzying array of numerical variables such as how cheap it was relative to the rest of the market, how quickly the stock had risen or declined, or a combination of the two—and much more. That night at the St. Regis was a golden hour for the quants, a predators’ ball for the pocket-protector set. They were celebrating their dominance of Wall Street, just as junk bond kings such as Michael Milken had ruled the financial world in the 1980s or swashbuckling, trade-from-the-hip hedge fund managers such as George Soros had conquered the Street in the 1990s. Muller flicked a lock of sandy brown hair from his eyes and snatched a glass of wine from a passing tray, looking for his friends.

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It started to climb as the Federal Reserve pumped massive sums of money into the system. The Dow finished the day up 102 points. The next day, it soared 186.84 points, its biggest one-day point advance in history at the time. But the damage had been done. The mood around the country turned decidedly anti–Wall Street as the junk bond scandals hit the front pages of newspapers. An October 1987 Newsweek cover queried, “Is the Party Over? A Jolt for Wall Street’s Whiz Kids.” In December 1987, audiences in movie theaters listened to Gordon Gekko, the slimy takeover artist played by Michael Douglas, proclaim the mantra for the decade in Oliver Stone’s Wall Street: “Greed is good.”

…

In mid-December 1987, an army of vans pulled up in front of a nondescript office complex in the heart of sleepy Princeton. A squad of fifty armed federal marshals clad in bulletproof vests burst from the vans and rushed into the office of Princeton/Newport Partners, which was perched in a small space over a Häagen-Dazs shop. They were searching for documents related to the fund’s dealings with Michael Milken’s junk bond empire at Drexel Burnham Lambert. The man in charge of the case was Rudolph Giuliani, the U.S. attorney for the Southern District of New York. He was trying to build more evidence for the government’s case against Drexel and was hoping employees of the hedge fund, threatened with stiff fines and possible prison terms, would turn against Milken.

Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism by Kevin Phillips

"World Economic Forum" Davos, Alan Greenspan, algorithmic trading, asset-backed security, bank run, banking crisis, Bear Stearns, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business cycle, buy and hold, collateralized debt obligation, computer age, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency peg, diversification, Doha Development Round, energy security, financial deregulation, financial engineering, financial innovation, fixed income, Francis Fukuyama: the end of history, George Gilder, Glass-Steagall Act, housing crisis, Hyman Minsky, imperial preference, income inequality, index arbitrage, index fund, interest rate derivative, interest rate swap, Joseph Schumpeter, junk bonds, Kenneth Rogoff, large denomination, Long Term Capital Management, low interest rates, market bubble, Martin Wolf, Menlo Park, Michael Milken, military-industrial complex, Minsky moment, mobile money, money market fund, Monroe Doctrine, moral hazard, mortgage debt, Myron Scholes, new economy, oil shale / tar sands, oil shock, old-boy network, peak oil, plutocrats, Ponzi scheme, profit maximization, prosperity theology / prosperity gospel / gospel of success, Renaissance Technologies, reserve currency, risk tolerance, risk/return, Robert Shiller, Ronald Reagan, Satyajit Das, Savings and loan crisis, shareholder value, short selling, sovereign wealth fund, stock buybacks, subprime mortgage crisis, The Chicago School, Thomas Malthus, too big to fail, trade route

For convenience, I call the quarter century ascent the Multi-bubble. The term is doubly descriptive—on one dimension, a simultaneous puffing up of stocks, debt, experimental finance, and the national role of financial services; on the second, a succession of bubbles from the savings-and-loan and junk bond 1980s to the technology-manic nineties and the ultimate great mortgage and debt bubble. The centrality of financial excess, I argue, is not a precursor of postindustrial evolution, but a perilous overconcentration visible in past leading world economic powers as they lost the broad vitality of earlier eras (see pp. 183-85).

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Bankers and savings and loan executives, handed new investment latitude by early 1980s deregulation, got our permissive quarter century off to a raucous start with an orgy of bad real estate loans, scams, financial toga parties, and Texas-sized insolvencies that led, beginning in 1989, to a $200 billion federal bailout. Ambitious financiers, some of whom also wound up in jail, explored grander new frontiers of debt issuance. Michael Milken pioneered high-yield or “junk” bonds for lower-rated corporate borrowers until his firm, Drexel Burnham, failed in 1991. Raiders like Henry Kravis, T. Boone Pickens, and Ivan Boesky made a household expletive out of the term “leveraged buyout”—the lucrative process by which companies were taken over, stripped, loaded up with debt, and sold off.

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We’ve never had a correction with these types of institutions and these types of instruments.”3 Others distilled the doubts about hedge funds themselves—the exotic quantitative mathematics, the obscure language of fixed-leg features and two-step binomial trees, and the humongous bank loans needed for the fifteen- or twenty-to-one leverage that alchemized mere decimal points into financial Olympic gold medals. New products often turned out to have Achilles’ heels, like the misbehaving index arbitrage of so-called program insurance, the derivative innovation widely blamed for the 1987 crash, and the junk bonds derogated after their inventor went to jail. In 2007, the failures were multiple: besides the CDO and exotic mortage embarrassments, hedge funds’ mathematical vulnerabilities included too many copycats doing the same thing, as well as an inability to deal with anarchic, almost random, volatility. . . .

Company: A Short History of a Revolutionary Idea by John Micklethwait, Adrian Wooldridge

affirmative action, AOL-Time Warner, barriers to entry, Bear Stearns, Bonfire of the Vanities, book value, borderless world, business process, Carl Icahn, Charles Lindbergh, classic study, company town, Corn Laws, Cornelius Vanderbilt, corporate governance, corporate raider, corporate social responsibility, creative destruction, credit crunch, crony capitalism, double entry bookkeeping, Etonian, Fairchild Semiconductor, financial engineering, Great Leap Forward, hiring and firing, Ida Tarbell, industrial cluster, invisible hand, James Watt: steam engine, John Perry Barlow, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, junk bonds, knowledge economy, knowledge worker, laissez-faire capitalism, manufacturing employment, market bubble, Michael Milken, military-industrial complex, mittelstand, new economy, North Sea oil, pneumatic tube, race to the bottom, railway mania, Ronald Coase, scientific management, Silicon Valley, six sigma, South Sea Bubble, Steve Jobs, Steve Wozniak, strikebreaker, The Nature of the Firm, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade route, transaction costs, Triangle Shirtwaist Factory, tulip mania, wage slave, William Shockley: the traitorous eight

In 1982, President Reagan made Milken’s job a little easier by allowing banks and, crucially, savings and loan institutions to buy corporate bonds. Between 1975 and 1986, some $71.5 billion of junk bonds were issued, with an average yield of 13.6 percent. In some ways, the merger boom ended in disaster. Junk bonds lived up to their name: around a fifth of the bonds issued from 1978 to 1983 had defaulted by 1988.18 Many of the thrifts that bought junk bonds went bankrupt, as did Drexel Burnham Lambert itself in February 1990. Milken was indicted on almost one hundred counts of racketeering—and eventually sent to jail. Across in Britain, Hanson’s ambition overran itself: after an unsuccessful play for ICI, its two founders effectively broke up the company in 1996.

…

At Safeway, for instance, where the company motto had been “Safeway offers security,” 63,000 people lost their jobs.17 LBOs, in turn, relied on another Wall Street invention: “junk bonds.” Wall Street had always traded bonds in distressed companies. The genius of Michael Milken was to create bonds specifically for this “non-investment-grade” market, opening up the market to ventures that were too small or risky to issue regular bonds. Milken first began to push his “high-yield” bonds in the 1970s; by the 1980s, his firm, Drexel Burnham Lambert, dominated the junk-bond market, and his annual Predators Ball in Los Angeles had become a fixture for entrepreneurs and politicians.

SUPERHUBS: How the Financial Elite and Their Networks Rule Our World by Sandra Navidi

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Alan Greenspan, Anthropocene, assortative mating, bank run, barriers to entry, Bear Stearns, Bernie Sanders, Black Swan, Blythe Masters, Bretton Woods, butterfly effect, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, commoditize, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, digital divide, diversification, Dunbar number, East Village, eat what you kill, Elon Musk, eurozone crisis, fake it until you make it, family office, financial engineering, financial repression, Gini coefficient, glass ceiling, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Google bus, Gordon Gekko, haute cuisine, high net worth, hindsight bias, income inequality, index fund, intangible asset, Jaron Lanier, Jim Simons, John Meriwether, junk bonds, Kenneth Arrow, Kenneth Rogoff, Kevin Roose, knowledge economy, London Whale, Long Term Capital Management, longitudinal study, Mark Zuckerberg, mass immigration, McMansion, mittelstand, Money creation, money market fund, Myron Scholes, NetJets, Network effects, no-fly zone, offshore financial centre, old-boy network, Parag Khanna, Paul Samuelson, peer-to-peer, performance metric, Peter Thiel, plutocrats, Ponzi scheme, power law, public intellectual, quantitative easing, Renaissance Technologies, rent-seeking, reserve currency, risk tolerance, Robert Gordon, Robert Shiller, rolodex, Satyajit Das, search costs, shareholder value, Sheryl Sandberg, Silicon Valley, social intelligence, sovereign wealth fund, Stephen Hawking, Steve Jobs, subprime mortgage crisis, systems thinking, tech billionaire, The Future of Employment, The Predators' Ball, The Rise and Fall of American Growth, too big to fail, Tyler Cowen, women in the workforce, young professional

I had a fabulous time and could not help but think that this was exactly how I had imagined this parallel universe to be when reading about it so many years earlier, half the world away. The tale of junk bond king Mike Milken is one of triumph, tragedy, redemption, and comeback. In the Gordon Gekko-ish 1980s, this ingenious financier revolutionized the financial system by opening up capital markets to companies which had previously not been considered creditworthy. He created a market and channeled billions of dollars into companies by issuing high-yield bonds, also dubbed junk bonds. So great was the boom he created that at some point it exceeded the financing of investment-grade companies.

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Despite his polarizing personality, most people—if only out of an abundance of caution—prefer to stay on good terms with him. Because of his many resilient links with other superhubs, his own superhub status is virtually guaranteed. DEN OF THIEVES: MIKE MILKEN When I lived in Germany, I read Den of Thieves, the tale of the 1980s “junk bond king,” Mike Milken. It provided insight into the epicenter of finance, a world of fascinating personalities and exciting transactions. I so longed to be there. A decade later, when I worked with famed economist Nouriel Roubini, we traveled to the Global Conference of the Milken Institute in Los Angeles, where he had a speaking engagement.

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In 1991 he founded the Milken Institute, which also hosts an annual global conference sometimes referred to as “Davos with palm trees,” although it is more U.S. and finance-sector centric than the annual gathering of the WEF. The conference takes place at the Beverly Hills Hotel, where Milken in his previous life had hosted his legendary junk bond conference called the “Predators’ Ball,” which has been colorfully immortalized in the book by the same title.8 Members of the financial elite, Washington power players, and world-renowned researchers attend the event. Billionaires Leon Black, Steve Schwarzman, Steven A. Cohen, Mort Zuckerman, and Richard LeFrak are regulars, as are former U.K. prime minister Tony Blair and Rwandan president Paul Kagame.

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof, Robert J. Shiller

affirmative action, Andrei Shleifer, asset-backed security, bank run, banking crisis, Bear Stearns, behavioural economics, business cycle, buy and hold, collateralized debt obligation, conceptual framework, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, Deng Xiaoping, Donald Trump, Edward Glaeser, en.wikipedia.org, experimental subject, financial innovation, full employment, Future Shock, George Akerlof, George Santayana, housing crisis, Hyman Minsky, income per capita, inflation targeting, invisible hand, Isaac Newton, Jane Jacobs, Jean Tirole, job satisfaction, Joseph Schumpeter, junk bonds, Long Term Capital Management, loss aversion, market bubble, market clearing, mental accounting, Michael Milken, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, new economy, New Urbanism, Paul Samuelson, Phillips curve, plutocrats, Post-Keynesian economics, price stability, profit maximization, public intellectual, purchasing power parity, random walk, Richard Thaler, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, seminal paper, South Sea Bubble, The Chicago School, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, W. E. B. Du Bois, We are all Keynesians now, working-age population, Y2K, Yom Kippur War

By the time the deal was closed, the surplus for the bidder would be insufficient to pay the transaction costs of the takeover.10 But Milken found a way to drastically reduce the cost of takeovers. He would enable deals to go through at near-lightning speed by using other people’s money. This money came straight from the S&Ls through their purchase of Milken’s junk bonds. If Milken or a Milken-connected enterprise made a hostile bid for a firm, it very much helped that he could guarantee a large part of the purchase through the sale of junk bonds. The S&Ls themselves did not need to be compensated— but their owners would receive “private prerogatives” from the sale, ensuring the smooth continuation of this practice. They would, for example, be given a form of option called a warrant, enabling them to buy the shares of the firm at a specified price.

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They would, for example, be given a form of option called a warrant, enabling them to buy the shares of the firm at a specified price. Milken is known to have allocated to himself quite a few warrants in these deals.11 Corporate executives discovered that they could take their firms private, floating large quantities of debt (as junk bonds) to pay off the stockholders. If the firms that had been taken private could pay off the junk bonds, these executives would be rewarded enormously. It was not long before the scale for executive pay had shifted dramatically upward. Graef Crystal, a leading consultant to executives on their compensation, was so appalled by the changes that he wrote a book entitled In Search of Excess.12 A new era of inequality, with new standards, had begun.

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The S&Ls were not worth anything as going enterprises—but they were worth a great deal for whatever sweetheart deals their owners could make. Such deals could involve real estate, with receipt of kickbacks from developers, or they could involve the purchase of risky but high-paying assets. The most inventive user of S&L sweetheart money was the junk bond impresario Michael Milken. Up until the 1980s the prevailing wisdom among economists had been that it was very difficult, if not impossible, to engage in a profitable hostile takeover bid. If the firm was undervalued before the bid was made, the bid itself would cause it to rise in value. By the time the deal was closed, the surplus for the bidder would be insufficient to pay the transaction costs of the takeover.10 But Milken found a way to drastically reduce the cost of takeovers.

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Eleventh Edition) by Burton G. Malkiel

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, beat the dealer, Bernie Madoff, bitcoin, book value, butter production in bangladesh, buttonwood tree, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Detroit bankruptcy, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, equity risk premium, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial engineering, financial innovation, financial repression, fixed income, framing effect, George Santayana, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Japanese asset price bubble, John Bogle, junk bonds, Long Term Capital Management, loss aversion, low interest rates, margin call, market bubble, Mary Meeker, money market fund, mortgage tax deduction, new economy, Own Your Own Home, PalmPilot, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Salesforce, short selling, Silicon Valley, South Sea Bubble, stock buybacks, stocks for the long run, sugar pill, survivorship bias, Teledyne, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond, zero-sum game

There is, however, another school of thought that advises investors to “just say no” to junk bonds. Most junk bonds have been issued as a result of a massive wave of corporate mergers, acquisitions, and leveraged (mainly debt-financed) buyouts. The junk-bond naysayers point out that lower credit bonds are most likely to be serviced in full only during good times in the economy. But watch out if the economy falters. So what’s a thoughtful investor to do? The answer depends in part on how well you sleep at night when you assume substantial investment risk. High-yield or junk-bond portfolios are not for insomniacs. Even with diversification, there is substantial risk in these investments.

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Should You Be a Bond-Market Junkie? Is the bond market immune to the maxim that investment risk and reward are related? Not at all! During most periods, so-called junk bonds (lower credit quality, higher-yielding bonds) have given investors a net rate of return 2 percentage points higher than the rate that could be earned on “investment-grade” bonds with high-quality credit ratings. In 2014 investment-grade bonds yielded about 4½ percent, whereas “junk” bonds often yielded 5 to 6 percent. Thus, even if 1 percent of the lower-grade bonds defaulted on their interest and principal payments and produced a total loss, a diversified portfolio of low-quality bonds would still produce net returns comparable to those available from a high-quality bond portfolio.

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Even with diversification, there is substantial risk in these investments. Moreover, they are not for investors who depend solely on interest payments as their major source of income. And they are certainly not for any investors who do not adequately diversify their holdings. However, at least historically, the gross-yield premium from junk bonds has more than compensated for actual default experience. Foreign Bonds There are many foreign countries whose bond yields are higher than those in the United States. This is particularly true in some emerging markets. Conventional wisdom has usually recommended against bonds from emerging markets, citing their high risk and poor quality.

All the Devils Are Here by Bethany McLean

Alan Greenspan, Asian financial crisis, asset-backed security, bank run, Bear Stearns, behavioural economics, Black-Scholes formula, Blythe Masters, break the buck, buy and hold, call centre, Carl Icahn, collateralized debt obligation, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, diversification, Dr. Strangelove, Exxon Valdez, fear of failure, financial innovation, fixed income, Glass-Steagall Act, high net worth, Home mortgage interest deduction, interest rate swap, junk bonds, Ken Thompson, laissez-faire capitalism, Long Term Capital Management, low interest rates, margin call, market bubble, market fundamentalism, Maui Hawaii, Michael Milken, money market fund, moral hazard, mortgage debt, Northern Rock, Own Your Own Home, Ponzi scheme, proprietary trading, quantitative trading / quantitative finance, race to the bottom, risk/return, Ronald Reagan, Rosa Parks, Savings and loan crisis, shareholder value, short selling, South Sea Bubble, statistical model, stock buybacks, tail risk, Tax Reform Act of 1986, telemarketer, the long tail, too big to fail, value at risk, zero-sum game

He was, in other words, a quant. Drexel in those days was best known for its most infamous executive, Michael Milken, the man who popularized junk bonds and built a huge business around them. Sosin wasn’t interested in junk bonds; instead, like any good quant, he gravitated toward complex derivatives, becoming one of the pioneers in developing ever more complicated forms of swaps. The problem for Sosin was that, at Drexel, derivatives were never going to replace junk bonds as the firm’s bread and butter. Drexel also didn’t have a particularly good credit rating, which meant its borrowing costs were higher than its competitors’.

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Tranching was also good for Wall Street, because the firms underwriting the mortgage-backed bonds could sell the various pieces for more money than the sum of the whole. And bankers could extract rich fees. Plus, of course, Wall Street could make money from trading the new securities. By 1983, according to Business Week, Ranieri’s mortgage finance group at Salomon Brothers accounted for close to half of Salomon’s $415 million in profits. Along with junk bonds, mortgage-backed bonds became a defining feature of the 1980s financial markets. Tranching, however, was not the only necessary ingredient. A second important factor was the involvement of the credit rating agencies: Moody’s, Standard & Poor’s, and, later, Fitch Ratings. Ranieri pushed hard to get the rating agencies involved, because he realized that investors were never going to be comfortable with—or, to be blunt, willing to work hard enough to understand—the intricacies of the hundreds or thousands of mortgages inside each security.

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If Fannie had remembered that, the company might have found its moral compass when it needed it most—and maybe left a different legacy. 4 Risky Business The most cutting-edge firm on Wall Street in the early 1990s was not Drexel Burnham Lambert, which had dominated the 1980s with its junk bonds, or Goldman Sachs, whose sheer moneymaking prowess would first dazzle and then repulse the country during this last decade. No, the firm that everyone on Wall Street wanted to emulate was a one-hundred-year-old commercial bank: J.P. Morgan. During the same era that the subprime mortgage industry was rising from the primordial ooze and Fannie Mae was consolidating its power over the mortgage securitization market, J.P.

How the City Really Works: The Definitive Guide to Money and Investing in London's Square Mile by Alexander Davidson

accounting loophole / creative accounting, algorithmic trading, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Bear Stearns, Big bang: deregulation of the City of London, buy and hold, capital asset pricing model, central bank independence, corporate governance, Credit Default Swap, currency risk, dematerialisation, discounted cash flows, diversified portfolio, double entry bookkeeping, Edward Lloyd's coffeehouse, Elliott wave, equity risk premium, Exxon Valdez, foreign exchange controls, forensic accounting, Glass-Steagall Act, global reserve currency, high net worth, index fund, inflation targeting, information security, intangible asset, interest rate derivative, interest rate swap, inverted yield curve, John Meriwether, junk bonds, London Interbank Offered Rate, Long Term Capital Management, low interest rates, margin call, market fundamentalism, Nick Leeson, North Sea oil, Northern Rock, pension reform, Piper Alpha, price stability, proprietary trading, purchasing power parity, Real Time Gross Settlement, reserve currency, Right to Buy, risk free rate, shareholder value, short selling, The Wealth of Nations by Adam Smith, transaction costs, value at risk, yield curve, zero-coupon bond

____________________________________________ CREDIT PRODUCTS 91  ‘Junk bonds’ is an unflattering term for those bonds classified by the rating agencies as sub-investment grade. Corporate bonds may have fallen to junk status due to a deterioration in the issuer’s financial performance. Junk bonds pay a high yield to compensate lenders for the credit risk of the issuer, just as banks lend on credit cards at a rate reflecting default experience. Their promoters call them high-yield bonds. Junk bonds from two companies that have the same yield may perform differently. Various forms of junk bond have been used to finance takeovers, and the product has a poor reputation.

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To compensate for this reinvestment risk, the callable bond will often pay a high coupon. 12 Credit products Introduction In this chapter, we will cover credit products, as distinct from the interest rate products covered in Chapter 11. We will focus on corporate bonds, international debt securities, junk bonds, asset-backed securities, zero-coupon bonds and equity convertibles. We will consider credit derivatives. Overview Credit products are integral to financial markets and help to fuel merger and acquisition activity, which, as we saw in Chapter 7, can keep equity market activity high. A predator will often finance a company takeover partly out of cheap debt, which has helped to keep credit markets buoyant.

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Various forms of junk bond have been used to finance takeovers, and the product has a poor reputation. Junk bonds are not acceptable as collateral for repo trades (see Chapter 11). Credit rating agencies The credit rating agency rates the creditworthiness of a bond. The higher the rating, the better the credit terms a borrower will receive. The major agencies are Standard & Poor’s, Moody’s Investment Services and Fitch Ratings. The rating is a paid-for service, which has called into question its independence. If a company does not buy a rating, some agencies have been known to publish it unsolicited, even if based on incomplete information. In rating a company, the agencies have access to non-public information and they estimate only the default risk.

The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street by Justin Fox

"Friedman doctrine" OR "shareholder theory", Abraham Wald, activist fund / activist shareholder / activist investor, Alan Greenspan, Albert Einstein, Andrei Shleifer, AOL-Time Warner, asset allocation, asset-backed security, bank run, beat the dealer, behavioural economics, Benoit Mandelbrot, Big Tech, Black Monday: stock market crash in 1987, Black-Scholes formula, book value, Bretton Woods, Brownian motion, business cycle, buy and hold, capital asset pricing model, card file, Carl Icahn, Cass Sunstein, collateralized debt obligation, compensation consultant, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, democratizing finance, Dennis Tito, discovery of the americas, diversification, diversified portfolio, Dr. Strangelove, Edward Glaeser, Edward Thorp, endowment effect, equity risk premium, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, George Akerlof, Glass-Steagall Act, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, information asymmetry, invisible hand, Isaac Newton, John Bogle, John Meriwether, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, junk bonds, Kenneth Arrow, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, low interest rates, mandelbrot fractal, market bubble, market design, Michael Milken, Myron Scholes, New Journalism, Nikolai Kondratiev, Paul Lévy, Paul Samuelson, pension reform, performance metric, Ponzi scheme, power law, prediction markets, proprietary trading, prudent man rule, pushing on a string, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, road to serfdom, Robert Bork, Robert Shiller, rolodex, Ronald Reagan, seminal paper, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, Skinner box, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, statistical model, stocks for the long run, tech worker, The Chicago School, The Myth of the Rational Market, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, Thorstein Veblen, Tobin tax, transaction costs, tulip mania, Two Sigma, Tyler Cowen, value at risk, Vanguard fund, Vilfredo Pareto, volatility smile, Yogi Berra

Louis Lowenstein, “Pruning Deadwood in Hostile Takeovers: A Proposal for Legislation,” Columbia Law Review (March 1983): 251–52. 33. Both the Milken background and the rise of the takeover artists are recounted in Connie Bruck, The Predators’ Ball: The Junk Bond Raiders and the Man Who Staked Them (New York: Simon & Schuster, 1988). Drexel was not the first firm to “manufacture” junk bonds; Lehman Brothers was, in 1977. But Drexel soon came to dominate the business. 34. Years later, after a federal judge had thrown Milken in jail for securities fraud, Chicago professor and soon-to-be law school dean Daniel Fischel wrote a book with the very unprofessorial title Payback: The Conspiracy to Destroy Michael Milken and His Financial Revolution (New York: HarperBusiness, 1995). 35.

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As an undergraduate at UC–Berkeley in the 1960s, Milken had come across a 1957 National Bureau of Economic Research study showing that low-grade bonds delivered better returns than high-grade ones. This made perfect capital asset pricing model sense: Bonds downgraded by S&P or Moody’s had been deemed riskier than bonds that hadn’t, so investors should reap a reward for buying them. While still in college, Milken began investing in these so-called junk bonds. When he went to work at the struggling brokerage firm Drexel Harriman Ripley after finishing his MBA at Wharton, he began building a business out of selling them. The bonds Milken sold in the early days hadn’t started out as “junk.” They were securities of “fallen angels,” companies that once seemed safe and secure but now weren’t, of which there were many in the 1970s.

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In 1971, while teaching at the University of Rochester, he began bringing in law professors from around the country for an annual summer economics institute. Later he started a similar program for federal judges. He also had the ear of the Reagan administration, which came to power in 1981. While hundreds of bills were introduced in Congress in the 1980s to rein in takeovers or junk bonds, none became law. When Reagan’s SEC chairman began worrying loudly in 1984 about the dangers of takeovers, Treasury Secretary Donald Regan, the former CEO of Merrill Lynch, made the administration’s position clear by stating that takeovers were “beneficial” as “they provide a means—sometimes the only feasible means—of policing management in widely held corporations.”35 A few months later, the annual Economic Report of the President included a whole chapter titled “The Market for Corporate Control”—written by a product of Chicago’s Economics Department—that was simply an updated version of Manne’s seminal 1965 article.36 The 1980s takeover boom did end eventually, shut down by state legislatures immune to Chicagoan reasoning, a U.S. attorney in Manhattan (Rudy Giuliani) intent on bringing down some big Wall Street names, and the crash of the junk bond market.

Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, Asian financial crisis, asset-backed security, Bear Stearns, beat the dealer, Black Swan, Black-Scholes formula, Bretton Woods, BRICs, Brownian motion, business logic, business process, buy and hold, buy low sell high, call centre, capital asset pricing model, collateralized debt obligation, commoditize, complexity theory, computerized trading, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, currency peg, currency risk, disinformation, disintermediation, diversification, diversified portfolio, Edward Thorp, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, financial engineering, financial innovation, fixed income, Glass-Steagall Act, Haight Ashbury, high net worth, implied volatility, index arbitrage, index card, index fund, interest rate derivative, interest rate swap, Isaac Newton, job satisfaction, John Bogle, John Meriwether, junk bonds, locking in a profit, Long Term Capital Management, low interest rates, mandelbrot fractal, margin call, market bubble, Marshall McLuhan, mass affluent, mega-rich, merger arbitrage, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mutually assured destruction, Myron Scholes, new economy, New Journalism, Nick Leeson, Nixon triggered the end of the Bretton Woods system, offshore financial centre, oil shock, Parkinson's law, placebo effect, Ponzi scheme, proprietary trading, purchasing power parity, quantitative trading / quantitative finance, random walk, regulatory arbitrage, Right to Buy, risk free rate, risk-adjusted returns, risk/return, Salesforce, Satyajit Das, shareholder value, short selling, short squeeze, South Sea Bubble, statistical model, technology bubble, the medium is the message, the new new thing, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, volatility smile, yield curve, Yogi Berra, zero-coupon bond

The derivative professionals dragged out a structure from the dim past – CBOs (Collateralized Bond Obligations). It was given a few nips and tucks and the odd shot of botox, but it was a CBO nevertheless. CBOs were the brainchild of Michael Milliken and Drexel Burnham Lambert (DBL), the creators of junk bonds (bonds issued by non-investment grade companies). CBOs were used to repackage junk bonds. Regulations required insurance companies holding junk bonds to provide a lot of reserves against the investment. To get around the rules, insurance companies repackaged the high yield assets into CBOs and transferred the riskier parts to their holding companies (which did not have to hold reserves).

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DAS_C06.QXP 8/7/06 4:43 PM Page 165 5 N The perfect storm – risk mismanagement by the numbers 165 Table 5.1 N Critical events 1987–2005 Year Event Details 1987 Stock market crash Dow Jones equity index falls 31% over one week with similar falls in other major global equity markets. 1990 Junk bond crisis Bankruptcy of Drexel Burnham Lambert and collapse of junk bond market. Collapse of US savings and loan institutions. 1991 ’First’ Gulf War Oil price characterized by extreme volatility. 1994 US interest rates US interest rates rise rapidly, triggering massive losses in highly leveraged derivative positions held by investors. 1994 Mexican crisis Mexican market collapses, triggering a significant emerging market liquidity crisis. 1997 Asian crisis Collapse of Asian equity and currency markets.

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CDOs are also massively leveraged: if you buy the 2% equity in a CDO, then you are 50 times leveraged, compared to the 10 to 12 times that a normal bank uses. Losses and leverage are not good bedfellows. Sound, highly-rated companies also found reefs. Asbestos liability and the Californian electricity deregulation claimed victims. As the credit cycle turned, the arbitrage CDOs were hard hit. They had been based on US high yield (junk) bonds. The US recession and the unwinding of the technology bubble saw record numbers of default. Contagious crises in Asia, Eastern Europe and Latin America didn’t help. The credit models failed miserably. The concept of average credit losses proved average – it seemed the worst case was much worse.

Black Edge: Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street by Sheelah Kolhatkar

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", "World Economic Forum" Davos, Bear Stearns, Bernie Madoff, Carl Icahn, Donald Trump, Fairchild Semiconductor, family office, fear of failure, financial deregulation, hiring and firing, income inequality, junk bonds, light touch regulation, locking in a profit, margin call, Market Wizards by Jack D. Schwager, medical residency, Michael Milken, mortgage debt, p-value, pets.com, Ponzi scheme, proprietary trading, rent control, Ronald Reagan, Savings and loan crisis, short selling, Silicon Valley, Skype, The Predators' Ball

The pace of mergers and acquisitions increased, fueled in part by Milken’s empire at Drexel Burnham Lambert, which had created a new way of financing corporate takeovers through high-yield debt, also known as junk bonds—which were ranked “below investment grade” by ratings agencies because they were riskier than other bonds. With these new instruments, companies that couldn’t borrow money could suddenly issue junk bonds, which gave them the financial resources to launch hostile takeovers of their competitors. Every day, rumors of these leveraged buyouts sent companies’ share prices soaring, earning millions for the traders buying and selling their stocks.

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He took the assignment as seriously as he would have if Cohen had been a member of his own family. In 1988 Michael Milken’s lawyers, when faced with a similarly daunting set of legal pressures, had taken the cynical tack of arguing that Milken was an American hero whose junk bond empire provided fuel for the U.S. economy. They described Milken as a “national treasure,” a “genius,” and a “national resource” and publicly argued that Milken’s work building the junk bond market had created value for companies and communities around the country. This argument actually had some validity. Milken had ushered in new methods for companies to borrow money and expand, especially companies considered too small or too risky to obtain traditional loans; his innovations had contributed to economic growth in ways modern-day hedge funds never had.

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Days before, he and his traders had all watched in horror as Drexel’s top mergers and acquisitions banker, Dennis Levine, was arrested and charged with orchestrating a massive insider trading scheme by paying off lawyers and bankers to leak him information about takeovers and other deals. The Levine arrest was just the beginning of the unraveling of Michael Milken’s junk bond empire, an unprecedented series of prosecutions that would dominate news headlines for months. The SEC accused Levine of accumulating $12.6 million in illegal profits and froze all his assets, preventing him from paying his legal bills. Around 6 P.M. on June 5, 1986, the same day that Levine pleaded guilty to tax evasion, securities fraud, and perjury and agreed to help the Justice Department by providing evidence against others committing crimes on Wall Street, Cohen arrived at 26 Federal Plaza, at Broadway and Worth Street, wearing his best suit.

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, backtesting, Bear Stearns, beat the dealer, Bernie Madoff, book value, BRICs, butter production in bangladesh, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial engineering, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Japanese asset price bubble, John Bogle, junk bonds, Long Term Capital Management, loss aversion, low interest rates, margin call, market bubble, Mary Meeker, money market fund, mortgage tax deduction, new economy, Own Your Own Home, PalmPilot, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stock buybacks, stocks for the long run, sugar pill, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

There is, however, another school of thought that advises investors to “just say no” to junk bonds. Most junk bonds have been issued as a result of a massive wave of corporate mergers, acquisitions, and leveraged (mainly debt-financed) buyouts. The junk-bond naysayers point out that lower credit bonds are most likely to be serviced in full only during good times in the economy. But watch out if the economy falters. So what’s a thoughtful investor to do? The answer depends in part on how well you sleep at night when you assume substantial investment risk. High-yield or junk-bond portfolios are not for insomniacs. Even with diversification, there is substantial risk in these investments.

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Should You Be a Bond-Market Junkie? Is the bond market immune to the maxim that investment risk and reward are related? Not at all! During most periods, so-called junk bonds (lower credit quality, higher-yielding bonds) have given investors a net rate of return two percentage points higher than the rate that could be earned on “investment-grade” bonds with high-quality credit ratings. In 2010 investment-grade bonds yielded about 6 percent, whereas “junk” bonds often yielded 8 percent. Thus, even if 2 percent of the lower-grade bonds defaulted on their interest and principal payments and produced a total loss, a diversified portfolio of low-quality bonds would still produce net returns comparable to those available from a high-quality bond portfolio.

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Even with diversification, there is substantial risk in these investments. Moreover, they are not for investors who depend solely on interest payments as their major source of income. And they are certainly not for any investors who do not adequately diversify their holdings. However, at least historically, the gross-yield premium from junk bonds has more than compensated for actual default experience. EXERCISE 8: TIPTOE THROUGH THE FIELDS OF GOLD, COLLECTIBLES, AND OTHER INVESTMENTS In previous editions of this book I took different positions on whether gold belongs in a well diversified portfolio. At the start of the 1980s, as gold had risen in price past $800 an ounce, I took a quite negative view of gold.

Toward Rational Exuberance: The Evolution of the Modern Stock Market by B. Mark Smith

Alan Greenspan, bank run, banking crisis, book value, business climate, business cycle, buy and hold, capital asset pricing model, compound rate of return, computerized trading, Cornelius Vanderbilt, credit crunch, cuban missile crisis, discounted cash flows, diversified portfolio, Donald Trump, equity risk premium, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, full employment, Glass-Steagall Act, income inequality, index arbitrage, index fund, joint-stock company, junk bonds, locking in a profit, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, market clearing, merger arbitrage, Michael Milken, money market fund, Myron Scholes, Paul Samuelson, price stability, prudent man rule, random walk, Richard Thaler, risk free rate, risk tolerance, Robert Bork, Robert Shiller, Ronald Reagan, scientific management, shareholder value, short selling, stocks for the long run, the market place, transaction costs

An early Wall Street Journal article about Milken noted the daring mixed with his shyness and self-effacement and went on to declare that “Mike Milken … is undisputed king of the junk bond market.” Milken’s junk bonds provided a means of raising the money necessary to finance many of the corporate takeovers that were the lifeblood of arbs like Boesky. The two men developed a close relationship, which included a Milken-arranged junk bond deal that raised more capital for Boesky’s firm. But the relationship ultimately proved to be too close. Milken was intimately involved in the investment banking activities of Drexel Burnham and therefore privy to advance knowledge of Drexel client merger transactions.

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They had reason to believe that Boesky had had improper dealings with one of the most powerful figures on Wall Street, a man who had revolutionized the way the Street did business. That man was Michael Milken. Michael Milken, of Drexel Burnham Lambert, was the apostle of what had become known as the junk bond revolution. By outward appearances he was hardly a natural salesman. Obviously shy, of lean stature, and wearing a toupee with curly brown hair that hid his premature baldness, Milken looked more like a meticulous accountant than a flamboyant promoter. Citing the academic studies he had come across while studying for his MBA at Wharton, Milken argued that bonds of lesser credit quality were unnecessarily shunned in the marketplace and therefore presented intriguing opportunities for investors.

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And one fellow risk arbitraguer, John Mulheren, became so enraged with Boesky’s revelations that he loaded an assault rifle, two semiautomatic pistols, and a shotgun into his car and set off to kill Boesky, only to be stopped by policemen who had been warned by Mulheren’s wife. Boesky was eventually sentenced to three years in prison, while Milken received ten years. The junk bond market collapsed under the weight of the investigation and an economic slowdown at the end of the 1980s, taking Drexel Burnham into bankruptcy. As one government attorney put it, Boesky “played fast and loose with the rules that govern our markets, with the effect of manipulating the outcome of financial transactions measured in the hundreds of millions of dollars.”

Dark Towers: Deutsche Bank, Donald Trump, and an Epic Trail of Destruction by David Enrich

"World Economic Forum" Davos, Affordable Care Act / Obamacare, Alan Greenspan, anti-globalists, Asian financial crisis, banking crisis, Bear Stearns, Berlin Wall, buy low sell high, collateralized debt obligation, commoditize, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Donald Trump, East Village, estate planning, Fall of the Berlin Wall, financial innovation, forensic accounting, high net worth, housing crisis, interest rate derivative, interest rate swap, Jeffrey Epstein, junk bonds, London Interbank Offered Rate, low interest rates, Lyft, Mikhail Gorbachev, NetJets, obamacare, offshore financial centre, post-materialism, proprietary trading, Quicken Loans, Ralph Waldo Emerson, Renaissance Technologies, risk tolerance, Robert Mercer, rolodex, SoftBank, sovereign wealth fund, Steve Bannon, too big to fail, transcontinental railway, Vision Fund, yield curve

Atlantic City casino refinancing: Casino City Times, “Trump Approved for $70 Million Bank Loan,” June 21, 2002. Taunting investors: Riva D. Atlas, “After His Gloom Went Over Like a Lead Balloon, Trump Tries to Sell Happiness, in Junk Bonds,” New York Times, May 7, 2002. story after preposterous story about his hijinks: David Enrich, “A Mar-a-Lago Weekend and an Act of God: Trump’s History with Deutsche Bank,” New York Times, March 18, 2019. Trump’s default on the junk bonds: Associated Press, “Trump Casinos File for Bankruptcy,” November 22, 2004; Emily Stewart, “The Backstory on Donald Trump’s Four Bankruptcies,” TheStreet.com, September 15, 2015.

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“But if you get this done, you’ll all be my guests at Mar-a-Lago.” Trump was always good at pushing an audience’s buttons—a weekend with Trump at Mar-a-Lago: bragging rights that not even money could buy—and this new incentive did the trick. The salesmen worked the phones, cast a wider net for more clients, and managed to sell an impressive $485 million of junk bonds (albeit at a high interest rate that reflected investors’ fears that Trump might default). When the sale was complete, Byrne delivered the good news to Trump, who was pumped. “Don’t forget what you promised our guys,” Byrne nudged his happy client. “What’s that?” Trump asked. Byrne reminded him about the Mar-a-Lago trip.

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At night, they dined at Mar-a-Lago, and Trump regaled them with story after preposterous story about his hijinks with casinos, real estate, Wall Street, and women. The following year, with his casinos on the rocks, Trump’s company stopped paying interest on the bonds and filed for bankruptcy protection. (“I don’t think it’s a failure; it’s a success,” Trump spun.) Deutsche’s clients, the ones who had recently bought the junk bonds, suffered painful losses. Going forward, Trump would be off-limits for Byrne’s division. The excommunication, however, didn’t apply to the whole bank. Trump soon went back to Justin Kennedy’s commercial real estate group, seeking another enormous loan. This one was to build a ninety-two-story skyscraper in Chicago, which Trump planned to name the Trump International Hotel & Tower.

Obliquity: Why Our Goals Are Best Achieved Indirectly by John Kay

Andrew Wiles, Asian financial crisis, Bear Stearns, behavioural economics, Berlin Wall, Boeing 747, bonus culture, British Empire, business process, Cass Sunstein, computer age, corporate raider, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, discovery of penicillin, diversification, Donald Trump, Fall of the Berlin Wall, financial innovation, Goodhart's law, Gordon Gekko, greed is good, invention of the telephone, invisible hand, Jane Jacobs, junk bonds, lateral thinking, Long Term Capital Management, long term incentive plan, Louis Pasteur, market fundamentalism, Myron Scholes, Nash equilibrium, pattern recognition, Paul Samuelson, purchasing power parity, RAND corporation, regulatory arbitrage, shareholder value, Simon Singh, Steve Jobs, Suez canal 1869, tacit knowledge, Thales of Miletus, The Death and Life of Great American Cities, The Predators' Ball, The Wealth of Nations by Adam Smith, ultimatum game, urban planning, value at risk

The businesses that epitomized the explosion of greed on Wall Street in the 1980s were Salomon Brothers (the firm mercilessly caricatured in Michael Lewis’s Liar’s Poker)12 and Drexel Burnham Lambert (more gently pilloried in Connie Bruck’s The Predators’ Ball).13 Salomon turned bond trading from a backwater into the activity of choice for the financially ambitious, while Drexel Burnham Lambert pioneered the issue of junk bonds. Salomon, whose abuses had exhausted the patience of the U.S. Treasury, had to be rescued by Warren Buffett (in a rare error) and was eventually taken over by Citigroup (which closed its trading operations). Drexel Burnham Lambert collapsed. In the following decade, the byword for greed was Bankers Trust, which sold derivative programs to large corporations and local authorities.

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Dunlap with Bob Andelman, Mean Business: How I Save Bad Companies and Make Good Companies Great (New York: Fireside, 1996), p. xii. 10 Securities and Exchange Commission, “Enforcement Proceedings,” SEC News Digest 2002-171, September 4, 2002. 11 Quoted in James B. Stewart, Den of Thieves (New York: Simon & Schuster, 1991), p. 223. 12 Michael Lewis, Liar’s Poker: Two Cities, True Greed (London: Hodder & Stoughton, 1989). 13 Connie Bruck, The Predators’ Ball: The Inside Story of Drexel Burnham and the Rise of the Junk Bond Raider (London: Penguin, 1989). 14 House Committee on Oversight and Government Reform, Transcript of Hearing (Richard Fuld), October 6, 2008. 15 Ken Auletta, Greed and Glory on Wall Street: The Fall of the House of Lehman (Harmondsworth, UK: Penguin, 1986), p. 235. 16 Lehman was at that time rescued by American Express, which floated the firm in 1994 ahead of its final collapse in 2008.

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Grand Rapids, MI: Zondervan, 1997. Brickman, P., D. Coates, and R. Janoff-Bulman. “Lottery Winners and Accident Victims: Is Happiness Relative?” Journal of Personality and Social Psychology 36, no. 8 (1978), pp. 917–27. Bruck, Connie. The Predators’ Ball: The Inside Story of Drexel Burnham and the Rise of the Junk Bond Raider. London: Penguin, 1989. Byrne, John A. The Whiz Kids: The Founding Fathers of American Business—and the Legacy They Left Us. New York: Bantam Doubleday Dell, 1993. Cahoone, Lawrence E., ed. From Modernism to Postmodernism: An Anthology. Edinburgh: Wiley-Blackwell, 2003. Carnegie, Andrew.

I.O.U.: Why Everyone Owes Everyone and No One Can Pay by John Lanchester

Alan Greenspan, asset-backed security, bank run, banking crisis, Bear Stearns, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, Black-Scholes formula, Blythe Masters, Celtic Tiger, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, financial engineering, financial innovation, fixed income, George Akerlof, Glass-Steagall Act, greed is good, Greenspan put, hedonic treadmill, hindsight bias, housing crisis, Hyman Minsky, intangible asset, interest rate swap, invisible hand, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", Jane Jacobs, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, junk bonds, Kickstarter, laissez-faire capitalism, light touch regulation, liquidity trap, Long Term Capital Management, loss aversion, low interest rates, Martin Wolf, money market fund, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, negative equity, new economy, Nick Leeson, Norman Mailer, Northern Rock, off-the-grid, Own Your Own Home, Ponzi scheme, quantitative easing, reserve currency, Right to Buy, risk-adjusted returns, Robert Shiller, Ronald Reagan, Savings and loan crisis, shareholder value, South Sea Bubble, statistical model, Tax Reform Act of 1986, The Great Moderation, the payments system, too big to fail, tulip mania, Tyler Cowen, value at risk

.* Any debt of BBB and above is known as “investment grade”; any below BBB is known as a “junk bond” on the basis that its level of risk is high—but that shouldn’t make it sound as if junk bonds are a marginal or unrespectable form of finance. (You may well feel that the distinction between investment and speculation is a little blurry and subjective, and you would be right. There is a character in one of Anthony Powell’s early novels, a retired major gone stone broke and living in a boardinghouse owing to “having squandered all his money in judicious investments.”) Because they have to pay high rates of interest, junk bonds can be very useful for investors; if they didn’t exist, only supersafe companies would be able to raise money, and all sorts of inventions and investments and growth would be impossible.

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That, in turn, makes everything worse for the entire economy. As Charles Morris points out in his book The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash, a credit bubble is a special category of event: “We are accustomed to thinking of bubbles and crashes in terms of specific markets—like junk bonds, commercial real estate, and tech stocks. Overpriced assets are like poison mushrooms. You eat them, you get sick, you learn to avoid them. A credit bubble is different. Credit is the air that financial markets breathe, and when the air is poisoned, there’s no place to hide.”10 What the banks want to be able to do is what most of us would do in comparable circumstances.

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It’s even safer than houses, because house prices go up and down; it’s safer than sticking your money under the mattress, because you might get burgled or your house might burn down. The status of AAA-grade debt is written into various statutes; many publicly regulated bodies aren’t allowed to invest in anything of lower grade than AAA. In other cases, institutions are legally prevented from investing in anything below BBB-grade debt, so-called junk bonds. The ratings agencies’ verdicts are so taken as holy writ that they are incorporated into the Basel rules on bank reserves. When governments lose AAA status for their debt, it is both an embarrassment and a potential disaster, because that means it’s going to be more expensive for them to raise money in the future.

Young Money: Inside the Hidden World of Wall Street's Post-Crash Recruits by Kevin Roose

activist fund / activist shareholder / activist investor, Basel III, Bear Stearns, Carl Icahn, cognitive dissonance, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, deal flow, discounted cash flows, Donald Trump, East Village, eat what you kill, eurozone crisis, financial engineering, fixed income, forward guidance, glass ceiling, Goldman Sachs: Vampire Squid, hedonic treadmill, information security, Jane Street, jitney, junk bonds, Kevin Roose, knowledge worker, Michael Milken, new economy, Occupy movement, off-the-grid, plutocrats, proprietary trading, Robert Shiller, selection bias, shareholder value, side project, Silicon Valley, Skype, Steve Jobs, tail risk, The Predators' Ball, too big to fail, two and twenty, urban planning, We are the 99%, work culture , young professional

Chapter Seventeen “A European debt crisis had been raging”: For more on the Euro zone crisis, see “Timeline: The Unfolding Eurozone Crisis,” BBC News, June 13, 2012. “Banks were still taking on huge, leveraged positions in opaque and little-regulated markets”: Dominic Elliott, “Basel Leverage Rules to Put Pressure on Wall Street,” Reuters Breakingviews, June 26, 2013. “The junk bond market…was having its strongest year since the crisis”: Matt Wirz and Shira Ovide, “Welcome to the Biggest Junk Bond Sale Since the Financial Crisis,” Wall Street Journal (Deal Journal), July 26, 2011. “that work lived on under the guise of ‘market-making’ trading desks”: Frank Partnoy and Jesse Eisinger, “What’s Inside America’s Banks?,” the Atlantic, January 2013.

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But Penn’s link with Wall Street is particularly tight because its Wharton School, a business program that contains both graduate students and undergrads, is considered America’s primo farm team for budding young financiers—a sort of West Point for Wall Street. More than half of Wharton’s six-hundred-person undergraduate class typically heads to banks, hedge funds, private equity firms, and other financial services companies after graduation. Among the celebrity financiers the school has churned out are SAC Capital billionaire Steven A. Cohen, the junk-bond impresario Michael Milken, and real estate megagoon Donald Trump. Wharton’s list of famous alumni, and the fact that its graduates emerge armed with advanced finance training, has made it a place where recruiters are prone to drooling. “Penn, and especially Wharton, is in a league of its own,” one hiring manager at a top Wall Street firm told me.

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All over Wall Street in 2011, financial firms were showing that although the crisis had changed some lines of business and consolidated the industry, the basic culture of risk taking and reward seeking was still very much intact. Banks were still taking on huge, leveraged positions in opaque and little-regulated markets. The junk bond market, which deals in high-yield corporate debt that is often issued by volatile and risky companies, was having its strongest year since the crisis. And although the Dodd-Frank act had effectively shut down the most obvious forms of proprietary trading at Wall Street firms, that work lived on under the guise of “market-making” trading desks, which were often functionally similar to their predecessors.

The New Tycoons: Inside the Trillion Dollar Private Equity Industry That Owns Everything by Jason Kelly

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, antiwork, barriers to entry, Bear Stearns, Berlin Wall, call centre, Carl Icahn, carried interest, collective bargaining, company town, corporate governance, corporate raider, Credit Default Swap, diversification, eat what you kill, Fall of the Berlin Wall, family office, financial engineering, fixed income, Goldman Sachs: Vampire Squid, Gordon Gekko, housing crisis, income inequality, junk bonds, Kevin Roose, late capitalism, margin call, Menlo Park, Michael Milken, military-industrial complex, Occupy movement, place-making, proprietary trading, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Rubik’s Cube, San Francisco homelessness, Sand Hill Road, Savings and loan crisis, shareholder value, side project, Silicon Valley, sovereign wealth fund, two and twenty

Because of that grade (given by credit rating agencies), investors demand to be compensated for the additional risk through more yield (interest) than they’d get from safer bonds issued by investment grade companies or the government. High-yield bonds are more colloquially called junk bonds. During 2005 through 2007, the high-yield debt market was perfectly situated for the purposes of leveraged buyouts. Investors were eager to invest in debt vehicles like collateralized loan obligations (CLOs), which were assembled by banks by piecing together lots of loans and then dividing them into slices according to risk. Junk bond funds also thrived, so there were willing buyers for both loans and bonds. Banks also used a number of products that helped fuel the boom.

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So he decided to make himself indispensable as Blackstone’s financier and later adviser on M&A. Lee was playing in an area once dominated by Drexel Burnham Lambert Inc., specifically by Michael Milken. It was Milken, a Drexel trader, who pioneered the use of high-yield, noninvestment-grade bonds (aka junk bonds), often in hostile takeovers. Drexel and Milken helped fuel the surge of mergers and acquisitions, including leveraged buyouts, during the 1980s. Milken was indicted for securities violations tied to insider trading, triggering Drexel to file for bankruptcy in 1990.1 While that eliminated a major provider of debt for LBOs, Drexel was a de facto training ground for a number of men who went on to create or work at major private-equity and investment firms.

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See also Blackstone Group appointing Blitzer cutting the deal with Oregon hiring people from DLJ on maturity of investments meeting with Oregonians proposal for acquisition of GSO on refinery reopening occasion role of work habits and drive Jarmin, Ron S. Jenkinson, Tim Jenrette, Richard Jeramaz-Larson, Kathy Job creation Job destruction/loss Johnson, Magic Johnson, Randy Jordan, Jay The Jordan Company JPMorgan JPMorgan Chase Juma Ventures Jumper, John Junk bond funds Kaplan, Steven Kaye, Charles KB Toys KCM Kennedy, Edward KFN. See KKR Financial Kiggen, Jamie King of Capital (Carey and Morris) KKR. See also Capstone consulting firm; Dollar General; KKR acquisitions; KKR takeovers; Kravis, Henry; Roberts, George; TXU annual revenues in Capmark changes at in Dubai Farr and filing S-1 on July gaining and loosing money Green Portfolio and headquarters of Hoffa on Knowlton advice about LeBlanc Teachers’ money commitment to Menlo Park office Nelson at number of workers on NYSE private equity of Teachers’ Retirement System of Texas and TPG and report on ESG issues KKR acquisitions: deals from 2005 to deals in Dollar General deal of HCA Regal Cinemas deal Safeway deal KKR Capital Markets KKR Financial KKR Millennium Fund KKR Private Equity Investors KKR takeovers: of RJR Nabisco of Samson Investment Co.

Broke: How to Survive the Middle Class Crisis by David Boyle

anti-communist, AOL-Time Warner, banking crisis, Berlin Wall, Big bang: deregulation of the City of London, Bonfire of the Vanities, bonus culture, call centre, collateralized debt obligation, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, deindustrialization, delayed gratification, Desert Island Discs, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, financial deregulation, financial independence, financial innovation, financial intermediation, Francis Fukuyama: the end of history, Frederick Winslow Taylor, gentrification, Goodhart's law, housing crisis, income inequality, Jane Jacobs, job satisfaction, John Bogle, junk bonds, Kickstarter, knowledge economy, knowledge worker, low interest rates, market fundamentalism, Martin Wolf, Mary Meeker, mega-rich, Money creation, mortgage debt, Neil Kinnock, Nelson Mandela, new economy, Nick Leeson, North Sea oil, Northern Rock, Ocado, Occupy movement, off grid, offshore financial centre, pension reform, pensions crisis, Plutonomy: Buying Luxury, Explaining Global Imbalances, Ponzi scheme, positional goods, precariat, quantitative easing, school choice, scientific management, Slavoj Žižek, social intelligence, subprime mortgage crisis, too big to fail, trickle-down economics, Vanguard fund, Walter Mischel, wealth creators, Winter of Discontent, work culture , working poor

It took watching his son being paid 225 grand at the age of twenty-seven, after two years on the job, to shake his faith in money.[26] Lewis was cutting his financial teeth in London and Wall Street at the height of the junk-bond boom. Bonds are simply agreements to pay a specific sum on a specific date in return for a loan. Junk bonds are those that are rated riskier than investment grade; the risk is that the issuer won’t pay. The upside is that junk bonds have a higher yield, and they allowed companies that couldn’t get conventional backing to launch themselves. The downside was that some of them were extremely risky. ‘The securities involve a high degree of risk,’ said the front page of one junk-bond prospectus two days after the 1987 Crash, ‘and accordingly, investors may lose their entire investment.’

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I haven’t worked twenty years to roll over and die like some unwanted sheep dog.’[17] But the zeitgeist seemed to be heading in the opposite direction, as the middle classes discovered high finance, and also found that they loved it. The sale of shares in British Telecom at the end of 1984 was five times oversubscribed, and there were frenetic scenes on the Stock Exchange trading floor. Takeover fever was mounting as the junk-bond revolution, emerging from a finance company in California called Drexel Burnham Lambert, began to load unrepayable debt onto the balance sheets of target companies in order to wrench them from their current management. The exchanges were beginning to boom. The FTSE 100 was launched at 1000 points in 1984.

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Edgar, 122 Hopkinson, David, 139, 146, 150 Horta-Osorio, Antonio, 155 Hoskyn, John, 59 hospital consultants, 89, 249 house-price inflation, 3, 15, 18, 20–1, 24, 55–85, 160, 280, 284, 286 ‘Barber Boom’, 56 and building societies’ cartel, 65–6, 71–3 and divorce, 79–80 and housing density, 78–9 and Lloyd’s scandal, 28, 32 and mortgage interest tax relief, 108–9 and rents, 68–9 and school catchments, 20, 210–11, 221 and size of houses, 77–9 and working couples, 74–6 house prices, 56, 61, 68–9, 74, 87 household loans, increase in, 69 housing market, parallel, 301–2 housing shortages, 56 Howard, Michael, 177 Howe, Elspeth, 58 Howe, Sir Geoffrey, 58–60, 62–7, 97, 99, 128, 130 Human Scale Education, 235 Hutber, Patrick, 5, 36–7, 45, 47, 55, 60, 174–5, 283 I IKB, 156 IMF, 59, 128 immigrants, 39 Imperial College, London, 140 income tax, 36 Independent, 118 Independent on Sunday, 175 index-linked funds, 197–8 Industrial Revolution, 152 inflation, 36, 58, 161, 199, 279–80, 284, 286, 289 Initial Rentokil, 295 Institute of New Economic Thinking, 157 insurance, 171 interest rates, artificially low, 195, 203 ISAs, 171 It’s a Wonderful Life, 122–3 Italy, 97, 299 J Japan, 75, 152, 176, 299 Jenkins, Simon, 72, 226, 266 Jersey, 147 Jews, 39 job seeker’s allowance, 271 jobbers, 136–7, 145–7 Johnson, Rob, 157 Johnson, Simon, 151 Jones, Owen, 68, 287–8 Joseph, Sir Keith, 58, 99, 177, 220 JP Morgan, 143, 152 Judd School, 216–17 Julius II, Pope, 278 Jung, Carl, 95 junk bonds, 148, 154 K Katz, Cindi, 46 Kay, John, 104 Kensington and Chelsea, 211 Kent, 216–19 Keynes, John Maynard, 157, 290 Killik, Paul, 147 King, Mervyn, 129–31, 141 King’s School, Tyneside, 238–9 Kingsland Foundation School, 204–6 Kinnock, Neil, 31 Kinsman, Francis, 174 Kozlowski, Dennis, 117 Kramer, Sebastian, 80 Kynaston, David, 130, 311 L Labour Party, 24, 66–7, 179, 182, 194, 287 Lambton, Lucinda, 224 Lane, Deborah, 11–14, 17 Latin American debt crisis, 71 Lawson, Nigel, 58–60, 62–6, 71–2, 128, 130 and building societies, 97, 99–100, 104 and City deregulation, 138, 149 and end of MIRAS, 108–9 and pension reforms, 177, 180–5, 188, 190, 194 Leeds, 225 Leeson, Nick, 158 Leigh-Pemberton, Robin, 151 leisure time, 17 Leith, William, 15, 83 Lewis, Michael, 153–4 Lewis, Roy, 37–9 Liberal Democrats, 211 libraries, 17 Little Venice, 1–2 Lloyd George, David, 38, 172, 255 Lloyd’s of London, 27–35, 50–1, 69, 286 Lloyds Bank, 71, 109, 118, 122, 155, 171 Local Enterprise Partnership, 293 localism, 299 Lockheed Martin, 132 London education, 210–11, 219, 221, 232, 240 housing, 68–9, 85 middle classes, 41–2 wealth disparities, 284 London Olympics, 221 London Oratory School, 228 London Rebuilding Society, 296 London School of Economics, 140–1 London Stock Exchange, deregulation of, 135–40, 147–51 M M&G, 139 McDonald’s, 47 Maclnnes, Colin, 305 McKinsey, 261, 266 ‘Macmillan Gap’, 152 McRae, Hamish, 118 Major, John, 30–1, 101, 176, 213, 258, 263–4 and education reforms, 221–5 Major, Stephen, 113 Manchester, 95, 189, 224, 255 Manchester High School for Girls, 225 Mandelson, Peter, 24, 263 Mangan, Lucy, 76 Marks & Spencer, 243, 248 Martin’s Bank, 96, 122 Marx, Karl, 272–3 Mass Observation, 40 Maude, Angus, 37–9 Maxwell, Robert, 190–1, 201 Meacher, Michael, 182 medical schools, 212 Meeker, Mary, 133 Merrill Lynch, 139, 155 Merton, 211, 213 Metroland, 82 Mexico, 200 Michelangelo, 278 Middle Class Association, 37 Middle Class Defence Organisation, 38 Middle Class International, 38 Middle Class Union, 38 middle-class values, 13–14, 46–9 aspiration, 88, 234 authenticity, 242 confidence, 87 corrosion by financial sector, 154–6, 158–62 education, 14, 45–6, 49–50, 204 independence, 52, 69, 84, 86, 174, 283 internationalism, 163 moderation, 125, 160 thrift, 36, 39, 45, 49, 108, 120, 160, 169, 174, 195, 283, 301, 305 tolerance, 47, 274 middle classes and assimilation, 39 average incomes, 274 ‘casualisation’ of, 175 and children’s intelligence, 229–30 Cobbett’s description of, 282–3 definitions of, 39–45, 52 demography, 35–6 differences of taste within, 305 disapproval and embarrassment, 46–9 disparities of wealth within, 116 impoverishment, 267–72 in London, 41–2 and racism, 230 solidarity with working classes, 289–90 and status, 20, 267 vilification of working classes, 230, 287–8 Middle England, 39 middle managers, 255 Middleton, Peter, 182 Miliband, Ed, 22 miners’ strike, 148, 288 Mischel, Walter, 45 Moody-Stuart, Elizabeth, 211 Morgan, John Pierpont, 143 Morgan Grenfell, 135 Morgan Stanley, 133 Morris, Peter, 175 Morris, William, 255 Morrison, Steve, 205 mortgage interest tax relief, 61, 108–9, 182 mortgages, 14–15, 18, 20, 203, 270, 287, 290 and building societies, 71–2, 97–8, 101 ‘Grandparent Mortgages’, 75 and house-price inflation, 56–7, 60–1, 65–6 interest-only, 75, 171 and lack of choice, 82–4 and multiples of salaries, 75 and rents, 68–9 see also remortgaging Mount, Ferdinand, 26 Mrs Miniver, 275 Muesli Belt, 44, 83 Multis, 43 musicals, 44, 53 N nannies, 169 napkin rings, 39–40 Nasdaq index, 155 National Association of Pension Funds, 180, 184, 191 National Childbirth Trust, 73, 164–5 National Health Service (NHS), 85, 177, 180, 249, 253–4, 260, 267, 291 National Insurance, 181–2, 184 National Lottery, 221, 253 National Theatre, 125–6 National Trust cafés, 87–9, 163 Nationwide Building Society, 112–14, 119 NatWest, 30, 71, 96 Neill Report, 33 Nelson, Admiral Horatio, 198 Nether Wallop, 245–7 Netscape, 114 New Economics Foundation, 116 New Labour, 230 New Public Management, 263–4 New York, 78, 122, 186, 218 New York Stock Exchange, 155 newspapers, 253 Nikko, 149 noise complaints, 78 Nonconformists, 39 Norman, Montagu, 95 North Sea oil, 64, 279 Northern Ireland, 221 Northern Rock, 72, 101, 110, 112, 118 Northwood, 73 Nottingham, 225, 238, 295 nurseries, 19, 76–7, 299 O Oakwood High School, 224 Obama administration, 152 Observer, 110 Occupy movement, 289–90 Office of Fair Trading (OFT), 135–6 Ofsted, 205–6, 231, 269 oil prices, 59, 299 old age pensions, introduction of, 38, 172 Oliver, Jamie, 295 One Per Cent, the, 23–6, 45, 69, 121, 159, 161, 163, 165, 193 O’Neal, Stanley, 155 Orpington, 162 Osborne, David, 261 Outhwaite, Dick, 30–1 outsourcing, 23, 26, 41, 160, 248, 285 Owen, Wilfred, 234 Oxford University, 80, 88, 234 P Pahl, Ray, 49 Palmer, Alasdair, 175 Parents’ Charter, 222–3 Parkinson, Cecil, 137–8, 149 parks, 17 Patten, John, 224, 226–8, 238 Pawson, Andrew, 233 Pearce, Edward, 62 Penhaligon, David, 102–3 Penman, Andrew, 213–14 pensions, 167–203, 270, 281, 284–5, 290, 302 annuities, 172, 196–7 automatic enrolment, 202 average pot, 204 Brown’s tax on, 19, 194 Conservative reforms, 176–85 defined benefit vs. defined contribution, 175–6, 195–6 and home ownership, 14, 19, 21, 85, 200–1, 203 mis-selling of, 188 occupational, 172–3, 175, 178, 185, 188, 190–3, 196–7, 201–2 public sector pensions, 43, 192, 202, 253 SERPs, 179–84 state pensions, 81, 178, 200–1 surpluses, 193–4 Pepper, Gordon, 66 Perry, Grayson, 289, 297, 305 pets, 10 Pinchin Denny, 138 Pinsent Masons, 189 plutonomy, 25, 143, 152, 159–60 political economy, 48, 51 Popcorn, Faith, 83 post offices, closure of, 252 Post-Autistic Economics campaign, 157 Potosí, 279–80 Power, Michael, 257 ‘Precariat’, 17 Pride and Prejudice, 281–2 Priestley, J.

Last Man Standing: The Ascent of Jamie Dimon and JPMorgan Chase by Duff McDonald

"World Economic Forum" Davos, Alan Greenspan, AOL-Time Warner, bank run, Bear Stearns, Blythe Masters, Bonfire of the Vanities, book value, business logic, centralized clearinghouse, collateralized debt obligation, conceptual framework, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Exxon Valdez, financial innovation, fixed income, G4S, Glass-Steagall Act, Greenspan put, housing crisis, interest rate swap, Jeff Bezos, John Meriwether, junk bonds, Kickstarter, laissez-faire capitalism, Long Term Capital Management, margin call, market bubble, Michael Milken, money market fund, moral hazard, negative equity, Nelson Mandela, Northern Rock, profit motive, proprietary trading, Renaissance Technologies, risk/return, Rod Stewart played at Stephen Schwarzman birthday party, Saturday Night Live, sovereign wealth fund, statistical model, Steve Ballmer, Steve Jobs, technology bubble, The Chicago School, too big to fail, Vanguard fund, zero-coupon bond, zero-sum game

At one point, when Dimon tried to jump into the conversation, Cole cut the young man off. “I’m sure you’re smart,” he said. “But I already have two geniuses here to answer my questions. I don’t need to hear from the junior genius as well.” • • • The following year was one of wrenching change in the financial markets. Michael Milken, the junk bond king at Drexel Burnham Lambert, was engulfed in an insider trading scandal, and would soon be indicted on racketeering charges. It was a stunning reversal of fortune for the firm, which in 1986 had been the most profitable investment bank on Wall Street. An era of swashbuckling buyouts and takeovers was coming to a shattering close.

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While Zarb and Weill wined and dined Drexel’s top producers in the hope of keeping them on board, the task of closing the deal once again fell to Dimon. Drexel’s collapse was, in and of itself, a big deal, especially considering the power the firm had wielded just months before. But there was also a growing sense that Drexel had helped much of Wall Street lose its way. Sure, the innovative use of junk bonds helped scrappy entrepreneurs like Ted Turner get their start. And although the much-chronicled junk-fueled takeover of RJR Nabisco by the private equity firm Kohlberg Kravis & Roberts provided high drama in the 1980s—trenchantly recounted in Bryan Burrough and John Helyar’s book Barbarians at the Gate—it seemed to many observers that such profligate use of debt forced proud companies to their knees and turned the august world of corporate finance into nothing more than a debased money grab.

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Dimon, a student of history, is constantly in disbelief at everyone else’s failure to learn from experience.) The RJR deal, feasted on by nearly every major financier in New York, ultimately came to be seen, according to Chernow, as “the era’s crowning folly.” In October, the collapse of a $6.79 billion buyout of United Airlines sent the markets into a tailspin as investors concluded that without the junk bond market to fuel ever-greater buyouts, stock prices had lost a crucial leg of support. By the end of the year, the economy was headed into recession. Britain’s Barclays Bank PLC started to feel the pinch earlier than many others, and in November decided to put its U.S.-based consumer loan division up for sale.

Market Sense and Nonsense by Jack D. Schwager

3Com Palm IPO, asset allocation, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, Brownian motion, buy and hold, collateralized debt obligation, commodity trading advisor, computerized trading, conceptual framework, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, global macro, high net worth, implied volatility, index arbitrage, index fund, Jim Simons, junk bonds, London Interbank Offered Rate, Long Term Capital Management, low interest rates, managed futures, margin call, market bubble, market fundamentalism, Market Wizards by Jack D. Schwager, merger arbitrage, negative equity, pattern recognition, performance metric, pets.com, Ponzi scheme, proprietary trading, quantitative trading / quantitative finance, random walk, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, selection bias, Sharpe ratio, short selling, statistical arbitrage, statistical model, subprime mortgage crisis, survivorship bias, tail risk, transaction costs, two-sided market, value at risk, yield curve

Also, the confusion between leverage and risk is one of the major misconceptions among hedge fund investors—a point fully discussed in Chapter 15. Credit risk. Many hedge funds in the credit space pursue a strategy of borrowing money at a relatively low interest rate and investing the proceeds in higher-yielding instruments (e.g., junk bonds). If money is borrowed at, say, 4 percent, and the junk bonds bought yield an average of 8 percent, then the hedge fund will earn a profit of 4 percent on borrowed amounts (and a full 8 percent on the assets under management, which do not have a borrow cost), assuming bond prices are unchanged. If the amount borrowed is equal to assets under management (leverage factor of two), the total gross return will be 12 percent (again assuming no change in bond prices).

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If the amount borrowed is equal to assets under management (leverage factor of two), the total gross return will be 12 percent (again assuming no change in bond prices). The larger the borrowings are (that is, the greater the leverage), the greater the potential return. If credit spreads (that is, the difference between high yield instruments, such as junk bonds, and U.S. Treasuries) are narrowing, profits will be even greater, as hedge funds will not only return a multiple of the yield difference between securities they buy and borrowing costs, but will also earn capital gains from appreciating bond prices (narrower credit spreads imply higher bond prices4).

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The event risk in this strategy, however, is that credit spreads do not follow a one-way street. Although credit spreads will fluctuate in moderate trading ranges most of the time, occasionally, during periods of financial crisis or elevated bankruptcies, credit spreads will widen sharply. During these events, steeply declining values in high-yielding debt securities (e.g., junk bonds, emerging market bonds) can lead to capital losses far greater than the yield differential earned. Note, for example, in Figure 4.4 the sustained negative returns in the HFR Fixed Income Corporate Index (an index of credit hedge funds) from mid-2007 through early 2009, coincident with the sharp widening of credit spreads.

Unreal Estate: Money, Ambition, and the Lust for Land in Los Angeles by Michael Gross

Albert Einstein, Ayatollah Khomeini, bank run, Bear Stearns, Bernie Madoff, California gold rush, Carl Icahn, clean water, Cornelius Vanderbilt, corporate raider, cotton gin, Donald Trump, estate planning, family office, financial engineering, financial independence, Henry Singleton, Irwin Jacobs, Joan Didion, junk bonds, Maui Hawaii, McMansion, Michael Milken, mortgage debt, Norman Mailer, offshore financial centre, oil rush, passive investing, pension reform, Ponzi scheme, Right to Buy, Robert Bork, Ronald Reagan, Silicon Valley, stem cell, Steve Jobs, Steve Wozniak, tech billionaire, Teledyne, The Predators' Ball, transcontinental railway, yellow journalism

A Bel Air mansion built between 1935 and 1938 for a nurse widowed by a rich older husband was then owned by Conrad Hilton, the hotel chain founder (and grandfather of Paris Hilton). It then passed to the owner of Dole Food, who made a staggering $58 million profit when he sold it in 2000 to a former junk bond trader who’d walked away from a public telecom company’s collapse with hundreds of millions of dollars. Greenacres, the mansion completed in 1929 by silent film star Harold Lloyd in Benedict Canyon in Beverly Hills, has since been owned by three Iranian businessmen; a record company mogul and his socially ambitious wife; Ted Field, the much-married Marshall Field heir who raced cars in the 1970s and ran Interscope Films and Interscope Records in the late 1980s; and most recently, the controversial supermarket billionaire, alleged model-hound, and former Friend of Bill (Clinton), Ron Burkle.

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Though it shelters a few big names like Richard Zanuck (the film-producer son of the legendary movie mogul Darryl Zanuck), who bought from Kenny Rogers; Magic Johnson, who stayed and built; and actor Samuel L. Jackson, its residents are mostly the lesser-known likes of real estate investors Daniel Blatteis and Paul Daneshrad; David Sydorick, a trader then with junk bond specialists Drexel Burnham Lambert and a classic race car collector; Dr. Mohammad Gharavi, chief of cardiovascular surgery at Providence Tarzana Medical Center; and former Midwest concert promoter Irv Zuckerman. And with memories of the ’87 crash already fading, half of North Beverly Park’s sixty-four lots were reserved by the time the house-building team moved into a new north gatehouse in 1990.

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Three years later, Murdock claimed victory after beating back an attempt by the Amalgamated Clothing and Textile Workers Union to organize Cannon’s workers—and promptly sold off most of the company. Several years after that, pensions at what remained of Cannon were cut because Murdock had invested pension pool assets in a junk-bond-holding insurance company that was seized by regulators. Though Murdock later wrote checks from his own pocket for nearly $1 million to cover some of the shortfall, bitterness lingered among retirees and former employees. Murdock may not have been close to the Reagan administration, but he was a poster child for its unemotional approach to American business.

740 Park: The Story of the World's Richest Apartment Building by Michael Gross

Alan Greenspan, Albert Einstein, anti-communist, Bear Stearns, Bonfire of the Vanities, California gold rush, Carl Icahn, company town, Cornelius Vanderbilt, corporate raider, cuban missile crisis, Donald Trump, Glass-Steagall Act, Irwin Jacobs, it's over 9,000, Jarndyce and Jarndyce, junk bonds, McMansion, Michael Milken, mortgage debt, Norman Mailer, offshore financial centre, oil shale / tar sands, plutocrats, Ronald Reagan, sensible shoes, short selling, strikebreaker, The Predators' Ball, traveling salesman, Upton Sinclair, urban planning

And in 1984, the magazine doubled its estimate again, to $400 million. His holding company, Reliance Group, was worth $3.7 billion. Steinberg’s personal net worth peaked in September 1987 at about $660 million, then dropped by a third in a stock market crash. In the early 1990s, Reliance stock was still sinking and it owed $650 million in junk-bond debt, but Forbes pegged Saul’s personal fortune at $330 million, plumped up by the sale of Reliance’s stakes in United Air Lines (for $100 million) and Days Inn ($765 million). Steinberg always used his money as if trying to live up to a boast he’d made after raiding Reliance. “Like the Rockefellers, I’ll own the world,” he’d said.

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So Ronald Jeançon, a past board president, once had to let Barbra Streisand’s broker know that the board would not even consider her because she was an actress and, worse than that, a singer. And Streisand is in good company. Others who have not made it into 740 include Joan Crawford, the late agent Ted Ashley, Neil Sedaka, the Daimler-Benz heir Friedrich Christian “Mick” Flick, the junk-bond tycoon Nelson Peltz, and, most recently, a Russian plutocrat, Leonard Blavatnik. For every rejection, there is a shareholder who wants . . . needs . . . to cash out and leave, but is held hostage by a difficult co-op board. And even when an applicant has passed the board, there are still more hurdles to get over.

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And then it was the twenties and they were financing bonds, financing electric power plants, all over the world.” Soon they’d forged ties with every power in the power business, raising the money that funded the industry’s expansion. “He was the Michael Milken of the twenties,” says Peter Thorne, comparing his grandfather to the junk-bond king of the 1980s who also made a fortune and changed the world by financing what seemed like risky new technology. In the fall of 1924, Thorne and Loomis engineered the creation of United Light and Power, merging utilities in nine states into a $34-million-a-year colossus—and also revealed that they’d secretly organized the American Superpower Corporation, which had acquired ownership interests in some of the largest power companies across the country.

Capitalism in America: A History by Adrian Wooldridge, Alan Greenspan

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, 2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, Affordable Care Act / Obamacare, agricultural Revolution, air freight, Airbnb, airline deregulation, Alan Greenspan, American Society of Civil Engineers: Report Card, Asian financial crisis, bank run, barriers to entry, Bear Stearns, Berlin Wall, Blitzscaling, Bonfire of the Vanities, book value, Bretton Woods, British Empire, business climate, business cycle, business process, California gold rush, Charles Lindbergh, cloud computing, collateralized debt obligation, collective bargaining, Corn Laws, Cornelius Vanderbilt, corporate governance, corporate raider, cotton gin, creative destruction, credit crunch, debt deflation, Deng Xiaoping, disruptive innovation, Donald Trump, driverless car, edge city, Elon Musk, equal pay for equal work, Everybody Ought to Be Rich, Fairchild Semiconductor, Fall of the Berlin Wall, fiat currency, financial deregulation, financial engineering, financial innovation, fixed income, Ford Model T, full employment, general purpose technology, George Gilder, germ theory of disease, Glass-Steagall Act, global supply chain, Great Leap Forward, guns versus butter model, hiring and firing, Ida Tarbell, income per capita, indoor plumbing, informal economy, interchangeable parts, invention of the telegraph, invention of the telephone, Isaac Newton, Jeff Bezos, jimmy wales, John Maynard Keynes: technological unemployment, Joseph Schumpeter, junk bonds, Kenneth Rogoff, Kitchen Debate, knowledge economy, knowledge worker, labor-force participation, land bank, Lewis Mumford, Louis Pasteur, low interest rates, low skilled workers, manufacturing employment, market bubble, Mason jar, mass immigration, McDonald's hot coffee lawsuit, means of production, Menlo Park, Mexican peso crisis / tequila crisis, Michael Milken, military-industrial complex, minimum wage unemployment, mortgage debt, Myron Scholes, Network effects, new economy, New Urbanism, Northern Rock, oil rush, oil shale / tar sands, oil shock, Peter Thiel, Phillips curve, plutocrats, pneumatic tube, popular capitalism, post-industrial society, postindustrial economy, price stability, Productivity paradox, public intellectual, purchasing power parity, Ralph Nader, Ralph Waldo Emerson, RAND corporation, refrigerator car, reserve currency, rising living standards, road to serfdom, Robert Gordon, Robert Solow, Ronald Reagan, Sand Hill Road, savings glut, scientific management, secular stagnation, Silicon Valley, Silicon Valley startup, Simon Kuznets, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, sovereign wealth fund, stem cell, Steve Jobs, Steve Wozniak, strikebreaker, supply-chain management, The Great Moderation, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, too big to fail, total factor productivity, trade route, transcontinental railway, tulip mania, Tyler Cowen, Tyler Cowen: Great Stagnation, union organizing, Unsafe at Any Speed, Upton Sinclair, urban sprawl, Vannevar Bush, vertical integration, War on Poverty, washing machines reduced drudgery, Washington Consensus, white flight, wikimedia commons, William Shockley: the traitorous eight, women in the workforce, Works Progress Administration, Yom Kippur War, young professional

They also became some of the most valuable tools in the restructuring wars: corporate raiders used them to buy shares in the companies that they wanted to take over, with a view to using the acquired companies’ assets to pay off their debts; and many targets of takeover attempts bought back their own shares from raiders at a premium. Junk bonds expanded from a mere 3.5 percent of the bond market in 1977 to a quarter of the market a decade later. Michael Milken became the symbol of the era, with his $550 million salary in a single year and his annual Predators’ Ball. Some of this looked too good to be true. Junk bonds lived up to their name: around a fifth of the bonds issued from 1978 to 1983 had defaulted by 1988. Many of the thrifts that bought junk bonds went bankrupt, as did Drexel Burnham itself in February 1990. Michael Milken was indicted on almost a hundred counts of racketeering, ending up in jail, and his company, Drexel Burnham, was forced into bankruptcy.

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Peter Drucker, who had made his name dissecting big companies, most notably General Motors in Concept of the Corporation, published a spirited book on entrepreneurship, Innovation and Entrepreneurship (1985). The new generation of entrepreneurs could draw on three resources that existed more abundantly in America than elsewhere, and that, when combined with an entrepreneur-friendly president in Washington, produced a business revolution. Financial innovators provided new sources of cash such as junk bonds from Michael Milken and venture capital from Silicon Valley’s well-established venture-capital industry. Great universities provided science parks, technology offices, business incubators, and venture funds. A liberal immigration policy provided a ready supply of willing hands and brains. Amar Bhidé of Tufts University suggests that “venturesome consumption” also promoted American entrepreneurialism.

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The financial services industry developed lots of ways of allowing people to borrow money so that they could acquire and transform underperforming companies: leveraged buyouts, or LBOs (which used debt to fund reorganizations); management buyouts, or MBOs (which were often used to sell off a proportion of the company); and “junk bonds.” The greatest champions of leverage were Kohlberg Kravis Roberts (KKR) and Drexel Burnham Lambert. In 1976, three young bankers with Bear Stearns, Henry Kravis, Jerome Kohlberg, and George Roberts, came up with the idea of a new kind of organization, a partnership that created a succession of investment funds, took positions in companies, and then sold them off after a fixed period of time.

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, behavioural economics, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Monday: stock market crash in 1987, Black Swan, Bonfire of the Vanities, bonus culture, book value, Bretton Woods, buy and hold, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, Cornelius Vanderbilt, corporate governance, Credit Default Swap, cross-subsidies, currency risk, dematerialisation, disinformation, disruptive innovation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial engineering, financial innovation, financial intermediation, financial thriller, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Greenspan put, Growth in a Time of Debt, Ida Tarbell, income inequality, index fund, inflation targeting, information asymmetry, intangible asset, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, it is difficult to get a man to understand something, when his salary depends on his not understanding it, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", Jim Simons, John Meriwether, junk bonds, light touch regulation, London Whale, Long Term Capital Management, loose coupling, low cost airline, M-Pesa, market design, Mary Meeker, megaproject, Michael Milken, millennium bug, mittelstand, Money creation, money market fund, moral hazard, mortgage debt, Myron Scholes, NetJets, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, Paul Samuelson, Paul Volcker talking about ATMs, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, reality distortion field, regulatory arbitrage, Renaissance Technologies, rent control, risk free rate, risk tolerance, road to serfdom, Robert Shiller, Ronald Reagan, Schrödinger's Cat, seminal paper, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, vertical integration, Washington Consensus, We are the 99%, Yom Kippur War

The contested takeover in 1988 of RJR Nabisco, the tobacco and food conglomerate, is described by Bryan Burrough and John Helyar in their book Barbarians at the Gate: The Fall of RJR Nabisco, perhaps the best business book of that decade.34 Burrough and Helyar end their book with the plaintive question ‘But what did it have to do with business?’ The question was pertinent. The era of Milken and junk bonds ended in farce. In early 1990 the Campeau Corporation, which had used junk bonds to acquire many of the USA’s leading department stores – Macy’s, Bloomingdale’s, Jordan Marsh – defaulted on its debt mountain. Robert Campeau, a Canadian property speculator, had no qualifications to run these businesses, only access to the funds of Milken’s clients. Appetite for junk bonds disappeared along with the hopes of the Campeau Corporation: Drexel Burnham Lambert, unable to refinance the bonds, went bankrupt: Milken went to prison.

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This occasion is widely described as the beginning of the application of shareholder value principles in American business: and as he implemented this strategy over the following two decades, Welch became America’s most admired business leader.32 In 1965 an American economist, Henry Manne, had coined the phrase ‘the market for corporate control’.33 The right to manage a corporation was an asset that could be bought and sold. Neglect of ‘shareholder value’ exposed managers to the threat of hostile takeovers. In the 1980s this threat intensified when Michael Milken of Drexel Burnham Lambert invented ‘junk bonds’, and found institutional investors to subscribe for them. These securities, which offered high yields and acknowledged high risks, enabled raiders to threaten even the largest company. The contested takeover in 1988 of RJR Nabisco, the tobacco and food conglomerate, is described by Bryan Burrough and John Helyar in their book Barbarians at the Gate: The Fall of RJR Nabisco, perhaps the best business book of that decade.34 Burrough and Helyar end their book with the plaintive question ‘But what did it have to do with business?’

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Within three months, all the directors were behind bars. Richard Whitney, president of the New York Stock Exchange, spent over three years in New York’s fearsome Sing Sing maximum-security gaol. Even in the early 1990s Charles Keating, the most notorious fraudster in the deregulation of US thrifts, and Michael Milken, the inventor of junk bonds, went to prison. Scapegoats for the new economy bubble were less harshly treated. The SEC devoted little energy or resource to identifying wrongdoing, and such cases were brought to light through the dogged investigations of now disgraced former New York Attorney General Eliot Spitzer. Frank Quattrone, the Crédit Suisse investment banker who expected favours from friends and clients in return for allocations of hot stocks, was prosecuted, though his conviction was overturned on appeal.

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby

Alan Greenspan, Andrei Shleifer, Asian financial crisis, asset-backed security, automated trading system, bank run, barriers to entry, Bear Stearns, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, book value, Bretton Woods, business cycle, buy and hold, capital controls, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency peg, deal flow, do well by doing good, Elliott wave, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, financial deregulation, financial engineering, financial innovation, financial intermediation, fixed income, full employment, German hyperinflation, High speed trading, index fund, Jim Simons, John Bogle, John Meriwether, junk bonds, Kenneth Rogoff, Kickstarter, Long Term Capital Management, low interest rates, machine translation, margin call, market bubble, market clearing, market fundamentalism, Market Wizards by Jack D. Schwager, Mary Meeker, merger arbitrage, Michael Milken, money market fund, moral hazard, Myron Scholes, natural language processing, Network effects, new economy, Nikolai Kondratiev, operational security, pattern recognition, Paul Samuelson, pre–internet, proprietary trading, public intellectual, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Mercer, rolodex, Savings and loan crisis, Sharpe ratio, short selling, short squeeze, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical arbitrage, statistical model, survivorship bias, tail risk, technology bubble, The Great Moderation, The Myth of the Rational Market, the new new thing, too big to fail, transaction costs, two and twenty, uptick rule

And by shorting the acquiring firms, he hedged out the risk from general market movements. Toward the end of the 1980s, Steyer expanded his horizons. This was partly a survival strategy, since the takeover boom skidded to a halt when the junk-bond market collapsed in 1989, leaving merger arbitrageurs with few mergers to analyze. But Steyer was playing offense too: The junk-bond collapse created an opportunity to apply his analytical skills in a different context.8 The companies at the center of the junk-bond market filed for bankruptcy one by one; and an investor who could figure out which piece of busted debt to buy was likely to profit handsomely. To make matters even better, pension funds, mutual funds, and other institutional investors were forced sellers of junk: Their rules forbade them to hold the bonds of companies in default, so they were compelled to concede bargains to nimble players such as Farallon.9 When Drexel Burnham Lambert, the kingpin of the junk-bond market, filed for bankruptcy in 1990, Steyer bought a large slice of its debt at cents on the dollar; and when he sold his stake in 1993, Farallon’s portfolio chalked up a 35 percent profit.10 With the Drexel transaction Steyer had scored a dazzling double.

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Soros was said to have enlarged his personal fortune by $650 million in 1992, and one magazine observed that it took Soros five minutes to earn what the median American family could expect for a full year of labor.50 A few years earlier, people had reacted with horrified fascination to the $550 million earned by Michael Milken, the champion of junk bonds; but now Milken had been surpassed. Soros became known as the man who broke the Bank of England, and hedge funds began to displace the 1980s buyout kings as the objects of popular envy. The full profits of the Soros funds were considerably larger than outsiders imagined. Just as Paul Jones had coupled his shorting of the equity market during the crash of 1987 with a profitable bet on bonds, so Drucken miller built out from his sterling coup.

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But nobody was fooled. The letter was leaked even before the last copy was faxed out, and the Wall Street Journal ran a front-page story the next day detailing Meriwether’s losses. Now the whole world knew that Long-Term was on deathwatch, and every player on Wall Street started to trade against it.41 Most junk bonds rallied in early September, but the particular bonds that LTCM owned remained dead in the water. Long-Term had a small position in hurricane bonds, securities that permit insurers to sell the risk of a hurricane; the day Meriwether’s letter leaked, the bonds plummeted 20 percent, even though the probability and cost of hurricanes was utterly unaltered.42 In Europe, the gap between government bonds and market interest rates widened in Britain and narrowed in Germany, for no fundamental reason other than that Long-Term was betting that the opposite would happen.

All About Asset Allocation, Second Edition by Richard Ferri

activist fund / activist shareholder / activist investor, Alan Greenspan, asset allocation, asset-backed security, barriers to entry, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, book value, buy and hold, capital controls, commoditize, commodity trading advisor, correlation coefficient, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, equity premium, equity risk premium, estate planning, financial independence, fixed income, full employment, high net worth, Home mortgage interest deduction, implied volatility, index fund, intangible asset, inverted yield curve, John Bogle, junk bonds, Long Term Capital Management, low interest rates, managed futures, Mason jar, money market fund, mortgage tax deduction, passive income, pattern recognition, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, selection bias, Sharpe ratio, stock buybacks, stocks for the long run, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve