Professor Elam

Sat May 1 2010

The initial run up in the stock market from 1982-87 was accompanied by the development of the junk bond market. An enterprising trader named Mike Milken realized that a lot of unrated or low rated debt was the lifeblood of many entrepreneurs. He argued that those entrepreneurs would not default as they would lose their entire business. And so people started investing in junk bond funds. A bond rates less than investment grade Baa is defined as  junk. Soon Milken raised the ante by convincing insurance companies to buy bonds which would be used to take over entire companies. Previously banks would not loan money for such purposes. Among the reasons, corporate boards usually had enough bankers sprinkled around to discourage that. And so corporate stalkers like KKR and Boone Pickens had treasure chest of money to mount 'green mail' attempted takeovers. Green mail being the polite term for black mail. 

It worked like this. Pickens would find an underperforming company like say Gulf Oil. Gulf was not finding as much oil as it was selling, its future was doomed. He realized that the execs would do anything to keep their jobs or secure their future, including selling the company. So, 

Milken raises money selling junk bonds for a takeover

Pickens uses the money to start acquiring shares of Gulf at say $30. Once Pickens has 10%, he has to register as a major shareholders. Now the stock price is rising. Pickens mounts a bid for a Board Seat saying the company is not delivering value for the shareholders. 

Terrified that they will all lose their phoney baloney jobs, as Mel Brooks put it in Blazing Saddles, the execs frantically turn to anyone to 'rescue' the company as a white knight. Anyone but Pickens, he will fire all of us, indeed he would. And so everyone starts buying Gulf, the price gets higher than it has ever been. Pickens then says, see I told you so these guys don't know how to raise the stock price, I do. 

In this particular case, Gulf turned to Chevron. In the meantime as the stock price rises, the execs of course vote themselves stock options to cash in on this unexpected turn of events. Now there is a bidding war and a proxy fight for votes to elect a new Board. The stock price soars past $50. 

The end of that story is that once the President of Gulf manages to get $10 M for his holdings, he announces they should sell to Chevron for $80. Gulf does just that. Chevron then of course fires everyone anyway. Pickens cashes out at $80 a share, making a bundle. He is easily able to re pay the junk bond holders and pocket the difference. He then looks for another target. 

 This is all a repeat of the milken deal, then an up and coming aggressive prosecutor named Rudi Guliani went after Milken to make a name for himself. Milken had become both the creator and market maker for the bonds he sold. And he managed to flaunt some securties laws in the process. Oh did I mention that Ivan Boesky and crew were using inside information to find out what happened at various companies and then used the junk bonds to acquire stock. The Gordon Gecko character in Wall Street the movie was modeled on Boesky. Boesky was another fraud claiming to be a brilliant investor while dealing inside information from Dennis Levine. 

Guliani was an ambitious prosecutor in the Justice Dept and zeroed in on Milken.  The whole story is told in the book at the left. Goldmnan is now doing about the same thing with CDS and derivatives that Milken did with junk bonds, insider trading, front running, playing themselves against the clients, etc.  

There is surely some one in the Justice Dept now that knows that same story, Rudi ended up Mayor of NYC, the quest for power in Wash DC never ends, and for a bunch of Justice Prosecutors, Goldman is a target rich environment.

End of the story

Guliani ended up Mayor of NYC

Milken now runs the Milken Institute and is good friends with Rudi

Chevron eventually gobbled Gulf, Texaco, and Unocal, and of course fired just about everyone at all those firms.

And no doubt Goldmand remembers that this process vaporized Drexel Burnham, Milken's firm. Seeking to avoid that they had best settle quickly. 

The stock market crashed in 1987 after prosecuting Milken, it crashed in 2000-02 after the government sued Microsoft, it crashed in 2008 after Greenspan inflated the money supply and people bought houses they could not afford, and now the government is going after Goldman, guess what happens next….