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I just finished reading Den of Thieves, a book by a Wall Street Journal reporter about the insider trading scandals of the 1980's.  Quite a bit of it was about Michael Milken, the financier best known as the "Junk Bond King," who remains a somewhat controversial figure.

Milken revolutionized corporate finance by making high-yield debt ("junk bonds") a major form of corporate capital.  Before Milken, pretty much no one wanted to buy junk bonds, which made them illiquid (you couldn't easily sell them the way you can with a stock) and thus even more undesirable.  Milken became a market-maker for junk bonds -- he would always buy them (albeit not necessarily at a price you'd like), and he had a ton of them (it was cheap for him to get them, since nobody else wanted them at first) to sell.  He was a good salesman (and also had the sales force of Drexel Burnham Lambert backing him up), and as the market-maker in a previously unserved investment market, was basically the only one with perfect information.  How much is a junk bond worth?  Basically, however much Milken says it's worth.  This information imbalance allowed Milken to charge insanely high commissions (up to 30%) on sales without anyone even knowing... and as long as everyone was making money, people generally didn't care to ask.

Milken became controversial because his power in the junk bond market let him raise almost arbitrary amounts of capital for any purpose -- he thus became the preferred financier of corporate raiders & hostile takeovers.  The stagnant business environment of the early 80's really needed some hostile takeovers, and so this wasn't really a bad thing -- but it was certainly unpopular with corporate managers, who of course made use of all the PR they could muster to complain about it.

The 80's on Wall Street was a time where insider trading and other securities violations were epidemic.  It was so ubiquitous that the temptation to engage in it was overwhelming -- the ease at which it could make you money, and the sense that "everyone was doing it" tempted a lot of people who didn't really seem like the criminal "type."  However, this morally lax environment started with people like Dennis Levine, a con artist who was very much the criminal type and was convincing people "everyone was doing it" well before everyone really was, and like Ivan Boesky, who went well beyond the usual Wall Street favor-trading into paying people in suitcases of cash laundered through casinos.

Milken was the last of a string of indictments against major Wall Street figures, the largest figure in a series of linked insider-trading rings.  He had been very cautious, but his co-conspirators all turned on him in order to get plea agreements -- each one handing over a bigger target to the U.S. attorneys until they got to Milken (who, as the biggest fish in the sea, had no one else to turn over.)  Milken fought the allegations until the end, and it seems quite clear that Milken himself did not believe he did anything wrong.  He still doesn't.

And interestingly, quite a few other people don't, either.  He was sentenced to 10 years in prison on six felony counts of securities laws violations, dealing with a large payment from Ivan Boesky (a $5.3 million kickback for inside information), undeclared action as a group (i.e. collaborating with others -- mainly Boesky again -- to make such large purchases as to cause major moves in a stock's price), and parking (sham purchase or sales of securities -- I'll get to this in the next paragraph.) However, these particular actions weren't really very significant compared to most of what Milken did -- what he was sentenced for was kind of like Al Capone's famous conviction for tax evasion.  It wasn't the main thing he did, it was just what they could get to stick.

In terms of illegal activities, convicting Milken of two parking counts was a serious understatement.  Parking was a regular part of Milken's investment strategy, he undoubtedly did it hundreds of times -- the argument over whether or not Milken is a criminal is really an argument as to whether or not parking should be illegal.  Parking securities is simply selling securities to someone else with the agreement to buy them back at the same price at a later date.  Thus, the new "owner" of the securities is not exposed to any risk -- they can neither make nor lose money.  There are basically three reasons to park securities with someone else:

1.)  Tax evasion.  If a stock is down, but you don't really want to sell it, you could sell it to someone else to report the loss on your taxes.  If the stock goes up later, you can buy it back and make just as much money as if you'd held onto it the whole time.
2.)  Concealing your interest.  If someone like Milken, frequently involved in hostile takeovers, accumulates 5-10% of a company, everyone will know that a takeover is imminent and bid the price up.  But if Milken buys shares in small blocks and parks them with others, it doesn't appear he's accumulating stock at all.
3.)  Evading net capital requirements.  Milken and arbitrageurs like Ivan Boesky made heavy use of leverage -- they would invest more money than they had.  Securities laws limit how much leverage you can use, requiring a percentage of "net capital" -- essentially, you have to be able to actually afford about 30% of the stock you're controlling.  If Boesky needed more cash, he could park some borrowed stock with Milken, thus keeping the stock (since Milken would give it back at the same price) and obtaining cash for additional leverage.

As you can see, none of these things are really stealing per se -- hence the controversy over Milken.  He was sentenced to 10 years for breaking administrative rules and avoiding taxes (something that most people would love to do anyway) -- a shockingly longer sentence than anyone else in these late-80's scandals.  He was also fined $650 million.

This said, though he was not convicted of insider trading at all, he did plenty of it... but by that time Levine's statement that "everyone else is doing it" had become true.  On one hand, this doesn't really excuse his actions, though on the other hand, his receiving a 10-year sentence for it while thousands of his colleagues went unpunished doesn't exactly radiate fairness, either.  The conviction of Milken and Boesky led almost directly to the stock-market crash of 1987; without the two of them, the takeover boom of the 1980's came to a screeching halt.  Without that bubble sustaining stock prices, and without Milken to do constant recapitalizations with ever-higher-yield junk bonds, many companies went into collapse.  In addition, Milken and others had managed to persuade many institutional investors -- including practically the entire savings-and-loan industry -- to invest heavily in Drexel-issued junk bonds.  Once Milken vanished from the scene, these, too, collapsed, this being one of the contributing factors to the S&L bailout fiasco.

Overall, it seems Milken was a case of a person who was amoral at best, and had undoubtedly committed many crimes... though most of them were of dubious criminality (though some were flagrant cases of deception and fraud.)  All told, though, it's hard to feel too bad for him... he served only 22 months of his 10-year sentence before being released, and being fined $650 million for his illegal activities still left him with about $1.1 billion from his legal junk-bond empire.  Today he's the 478th richest man in the world, with over $2.2 billion, though being barred for life from the securities industry means he won't likely make much more money.  He devotes his time to philanthropy, something he'd been doing since 1970 (and is just now able to do on a much larger scale.)  He continues to have a staggering ego and steadfastly maintains his innocence.

What I find most fascinating about him is that he turned to crime -- and on such a phenomenal scale -- at all.  (Whether or not what he did was wrong, there's certainly no doubt it was criminal and the lengths he went to to conceal it shows he knew it, too.)  He was already wealthy when he started the junk-bond business at Drexel Burnham, and his legal operations generated an amazing amount of money (Drexel paid him a $550 million bonus in one year!)  What makes a person who has a billion dollars risk prison for half a billion more?  I think it's a case of a person who's actually risk-seeking -- desiring to do something dangerous for its own sake, not enjoying the game unless he has a chance of losing.  It's a rather alien mindset for me.

Date: 2007-06-17 07:54 pm (UTC)
From: [identity profile] kimatha.livejournal.com
What I find most fascinating about him is that he turned to crime -- and on such a phenomenal scale -- at all.

Yeah, I don't understand that either.

Sounds like a good book!

Date: 2007-06-19 04:19 am (UTC)
From: [identity profile] jorend.livejournal.com
Thanks for writing this.

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