This weekend’s Barron’s contains an excellent Up and Down Wall Street column from Kopin Tan concerning the vast similarities between this moment in market time and the middle of the 1980’s. In addition to the pop culture references (Shoulder pads are back! Japan is ascendant, etc) he cites the spike in 80’s era takeover tactics, activist greenmailing and the general climate of LBO maneuvering.
So why are these old stunts hot again? For a start, leverage — which juiced deal-making 30 years ago and provided the L in LBO, the three letters that helped define the ’80s — is very cheap, thanks to the tireless money-printing by the Fed (the three letters that will come to define this decade).
Kopin doesn’t get into what was driving the deal-making explosion of the 1980’s, but I will: Easy money, just like today, but coming from an entirely different source.
So if we have the Fed now keeping corporate balance sheets overflowing like the fabled horn of plenty, then who was supplying all this monetary largesse during the takeover frenzy of the 80’s? Certainly not then-Fed Chairman Paul Volcker, the relentless inflation fighter. And Easy Alan Greenspan, his successor, didn’t really arrive on the scene until just before 1987.
The answer is Michael Milken. It was his firm Drexel Burnham that kept the crowd dancing before quantitative easing was even a gleam in the FOMC’s eye.
Before QE, there was leveraged finance in the form of junk bond issuance, and Milken turned what was originally a bond-market backwater into a $200 billion centrifugal force around which the entire universe turned. Companies could use the junk bond market to buy other companies. Investors could use it to take controlling stakes in companies. Activists could use it to threaten boards with hostile action. The boards themselves could use it to buy back stock or even to erect defensive positions around their corporations. The sun rose and set based on who could fund what in the 1980’s and that funding was coming increasingly from the massive amounts of capital Milken and his guys were able to raise.
It all began with the very first leveraged buyout in 1982, at the dawn of the new bull market when up-and-coming financiers were just beginning to sow their oats. Here’s an account from the Orlando Sentinel of those early beginnings:
For example, in a 1982 deal that was the first well-publicized LBO, former Treasury Secretary William Simon led a group that put down only $1 million to complete the $80 million purchase of Gibson Greetings, the card company. By the time Simon’s group sold the company a year and a half later, Simon’s own initial investment of $330,000 was worth $66 million.
Such numbers tend to attract attention.
Although Milken was not involved in the Gibson deal, he picked up and advanced the idea through junk bonds.
Steve Wynn, the casino magnate, parlayed a $2 million stake into a net worth of $75 million through the use of junk bonds, according to Predators’ Ball: The Junk Bond Raiders and the Man Who Staked Them. Nelson Peltz, who headed the obscure Triangle Industries, was able to buy National Can Co. – six times larger than his own company – through the use of Drexel junk bonds.
The similarities between the role Milken played 30 years ago and the Fed is playing now are unmistakable.
In those days, the demand for high-yield paper coming from the investor class was so substantial (in part thanks to highly persuasive brokers) that Drexel Burnham could sell bonds of any quality or quantity, practically in its sleep. If you were a corporate issuer or a tenured investor, whatever you wanted to raise funds to do, Milken’s salespeople could probably find the capital for you to do it.
Nowadays, the Fed floods the marketplace with essentially free investment capital, bolstering corporate balance sheets with an astonishing $1.3 trillion in cash. With its endless purchases of bonds and its rock-solid guarantee to hold rates down near zero, it also enables the borrowings of just about anyone who steps up to the plate. Once again – whatever you want to do, the money’s there to do it.
There are, of course, some important differences worth noting between Drexel in the 80’s and today’s Federal Reserve. Milken’s epic junk bomb never had the imprimatur of necessity that the Fed’s open market operations and economic stimulus enjoy today – the junk bond king was merely pursuing a capitalist opportunity in the 1980’s while the modern Fed has been trying to revive the economy.
But their elemental effect on the investment markets is essentially the same. And by the way, junk bonds are back in a major way, as a symptom of the bountiful Fed. And this time, we’re not talking truly high yields…
Here’s Tan again:
Like hair, junk bonds also were big in the ’80s. But something’s different about today’s junk boomlet: Investors seem far too willing to accept lower yields for taking on the risk of buying these bonds. In fact, the average yield in the junk market had never fallen below 6% before this year, but now slumps near 5.6%.
The largest provider of liquidity in the markets is always going to be the one playing the tune. We are left to hope that he knows when to change it.