Don't Pardon the Junk Bond King
Many politicos mark the 1980s as the beginning of the financial era that is now crashing around us. It's is fitting then, that one of the original financial felons from that time period, Michael Milken, is asking for a pardon from President Bush. In the 1980s Milken's finance schemes set off a string of hostile takeovers and he and his cohorts became known as "Corporate Raiders", with Milken, the "Junk Bond King". His security fraud convictions may be almost forgotten, and it is doubtful that he will receive a pardon on the last day of Bush's presidency, but Milken's financial revolutions deserve to be remembered because they typify the type of capitalism gone awry that is at the root of our 21st century financial crisis.
I'm not talking about the hard working innovative entrepreneurs that have created so many valuable companies here. I'm talking about the side of our society that has condoned so much lawless corruption in financial services that the foundation of our economy is crumbling.
Thirty years ago Michael Milken was a key innovator in new ways to finance B grade companies with money that wasn't there -- but could be if unrecognized assets were tapped. What he got people to bet on was the possibility that by cutting "costs" (usually jobs) these undervalued companies would become hugely profitable. For a while he was right, until his house of cards came down a few years later and bankrupted his company, Drexel Burnham Lambert, the 5th largest investment bank in the nation. Milken ended up getting himself and Drexel sued by the SEC and U.S. Attorney Rudy Giuliani for insider trading, stock manipulation, defrauding its clients, and stock parking.
Before all this Milken was a golden boy financial whiz kid from Wharton. He was a numbers guy, to the extreme. He wasn't very social and didn't even spend his extravagant wealth very extravagantly, (in 1987 he made $550 million). Still, he managed to almost single-mindedly change the structure of our capital markets. The biggest impact came from Milken's new method of creating liquidity in bond markets. He shifted the responsibility of running a company from the managers, who owned little of its stock, to the new shareholders. It worked well if the new shareholders fired employees and sold off assets to create quick short-term profits, and it created huge fees for the new breed of money managers under Milken.
All this was promoted as a healthy shake up for corporate America. Milken saw himself and his ilk as beacons for a new more democratic form of financing, opening up access to corporate America. He still argues that his work helped to cut out the fat and made our economy leaner and stronger. But what really happened?
According to Social Science Quarterly, Americans now have the highest income inequality of any nation in the "developed world", and its been growing worse for thirty years.
Statistics also show that from 1800 until the 1980s, the United States paid the highest wages in the world (Peter Lindert, National Bureau of Economic Research). But since the 1980s, shareholders have earned record profits, while the portion of the productivity enjoyed by the average American has declined. In the last thirty years millions of good paying jobs have gone overseas in every industry from banking to electronics and films. What started with a giddy push for unregulated market fundamentalism ended up leading to a growth in income inequality not seen since "The Gilded Age". Instead of creating a more democratic meritocracy, this unregulated business expansion has gutted our middle class, led to unsustainable destruction of our environment, and endangered our ability to dissent.
The thinking of the Reagan era was that unrestrained self-interested greed would fuel growth and be good for everyone. "Greed is good" became the commonplace mantra, but underneath there was another unspoken mantra -- in this free market nobody is watching, so "crime pays".
Michael Milken plead guilty to 6 felony counts of securities fraud and spent 18 months in prison. He paid $200 million in fines, and several hundred million in other civil fees. It is well documented in the fascinating book The Den of Thieves, by Wall St. Journal writer, James B Stewart, how Milken collaborated with Ivan Boesky on inside trading deals they just couldn't resist. Milken claims on his website that his infractions were minor non-disclosure technicalities that never should have been a crime. But Milken and his associates made millions of profit illicitly, and on top of that they caused hundreds of millions in damages and immeasurable environmental losses from some of their nefarious deals.
The takeover of Pacific Lumber by Maxxam Corp in 1985 was part of the Milken/Boesky insider trading scandal. Pacific Lumber held the largest stands of ancient Redwoods left in the world. The family that once owned the company had been running it in a sustainable fashion for over a hundred years. It seemed like the perfect undervalued corporation to Milken and Charles Hurwitz, CEO of Maxxam. They could double the rate of cutting and afford the high interest loan. Other business people warned it wasn't feasible to cut the last of the 2000-year old redwoods and ruin this idyllic forest.
Hurwitz didn't mind though. He set in motion the largest acceleration in logging California had ever seen. In order to pay off the junk bond debt he looted the PL pension fund and started clear-cutting whole hillsides. The huge shift alarmed the local population and regional environmentalists and years of political actions, lawsuits, and tree-sits ensued.
The costs of the Pacific Lumber takeover were more than monetary to the environmental activists (including this writer) who worked tirelessly for over 20 years to stop Hurwitz's unsustainable and often illegal logging practices. Paying a high price were prominent redwood activists Judi Bari and Darryl Cherney, who were the targets of a car bombing in 1990 and then accused of bombing themselves. The eloquent and outspoken adversary of Pacific Lumber, Judi Bari was nearly killed in the bombing, and later died of cancer. The duo sued the FBI and Oakland Police, and in 2002, and were awarded a $4.4 million jury settlement for violations of their first and fourth amendment rights.
The public also paid a dearly to preserve the ancient redwoods Hurwitz had bought. After years of effort, activists were able to work with Senator Diane Feinstein to convince the federal and state governments to buy the last groves of old growth redwoods, Headwaters Forest, at a cost of $495 million, and a couple hundred million more in tax breaks.
The actions that Milken set off still affect us today. Just last year, in 2008, Pacific Lumber went bankrupt and then was bought out by one of the owners of The Gap, who promised to proceed in a sustainable fashion. But the company is just a shadow of its former self, with most of California's redwoods gone and most of the mills closed. The years of careless logging also ruined the coastal rivers that so many salmon used to spawn in. In 2008 the commercial salmon industry in California was so diminished it was shut down and had to be bailed out with $100 million. While the loss of jobs and financial impact on these industries can be measured, we must also add the vast unknown costs of destroying a forest -- which contributed greatly to global climate change and species extinction.
To be fair, Milken alone can't be blamed for all these costs. But his work in the 1980s spearheaded a predatory lending style economy and the mentality that growth for shareholders was the same as real productivity. It was a delusion for all these years, allowing us to imagine that these other costs didn't exist.
Now our financial meltdown is making us realize that maybe it isn't the best idea to have only super smart numbers guys leading our economy. We've learned that profits alone can't be the only thing that matters, that sustainability, jobs, and community have to have a place. Don't get me wrong; I'm not against making money or creative entrepreneurialism. But we need to change our mindset about the role of business. I believe some of these extremes never did represent many conservatives who do care about their communities. But in the name of growth, too many of us tolerated an incredible amount of damaging corruption that overwhelmingly benefited the few at the top of our society. For leading this trend, Milken is completely unrepentant. Although he has funded cancer research and many philanthropic activities, he most certainly does not deserve a pardon. Rather it is he, who should be expressing an apology to us.