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Ex-Con Mike Milken Shows Us the Way

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Author: Brian McMorris

Some of you may remember Michael Milken. He was The Bad Boy from the 1980s leveraged buyout (LBO) craze and the father of modern junk bond debt financing to conduct LBOs. He ran the Drexel Burnham Lambert high yield bond desk until 1989 at which point, he ran it into the ground and in 1990, DBL out of business. For this and other mischief and overreaching, he earned himself a one-way ticket to Federal prison for SEC violations in his dealings with client and fellow Bad Boy, Ivan Boesky. Milken served a two year prison sentence and apparently came back a changed and philanthropic man.

So, if anyone can speak with authority on the national bond market and what it means to business, it should be Michael Milken. How refreshing he has turned his formidable analytical powers to helping the rest of us understand the bond market.

Today (Tuesday, August 21) in the WSJ, Milken published an editorial on the corporate bond market drawing parallels to the mid 1970s. Those of you that are loyal "Wealth-Ed" readers know that I am of the opinion that history is a prelude to the future, that is history (almost) repeats. I have also noted the market similarities between now and the mid 1970s as well as the late 1930s. Milken puts some specific analysis behind that speculation.

In Milken's opinion, we are working through the worst of times and not far from much better times. I have been recommending investments in the high yield bond market as the spreads (TED spread) between high yield and Treasuries were until recently at record levels. The fact those spreads are improving shows healing in the market. The bond market almost always gets the story right before the stock market. So an improving high yield market is a good indicator for stocks and the economy.


APRIL 21, 2009

Why Capital Structure Matters

Companies that repurchased stock


Thirty-five years ago business publications were writing that major money-center banks would fail, and quoted investors who said, "I'll never own a stock again!" Meanwhile, some state and local governments as well as utilities seemed on the brink of collapse. Corporate debt often sold for pennies on the dollar while profitable, growing companies were starved for capital.

Chad Crowe

If that all sounds familiar today, it's worth remembering that 1974 was also a turning point. With financial institutions weakened by the recession, public and private markets began displacing banks as the source of most corporate financing. Bonds rallied strongly in 1975-76, providing underpinning for the stock market, which rose 75.

The accessibility of capital markets has grown continuously since 1974. Businesses are not as dependent on banks, which now own less than a third of the loans they originate. In the first quarter of 2009, many corporations took advantage of low absolute levels of interest rates to raise $840 billion in the global bond market. That's 100 of their value in less than a year because they were too highly leveraged and too dependent on commercial paper at a time when interest rates were doubling. This time around it was a combination of excessive leverage in real-estate-related financial instruments, a serious lowering of underwriting standards, and ratings that bore little relationship to reality. The experience of both periods highlights two fallacies that seem to recur in 20-year cycles: that any loan to real estate is a good loan, and that property values always rise. Fact: Over the past 120 years, home prices have declined about 40% of the time.

History isn't a sine wave of endlessly repeated patterns. It's more like a helix that brings similar events around in a different orbit. But what we see today does echo the 1970s, as companies use the capital markets to push out debt maturities and pay off loans. That gives them breathing room and provides hope that history will repeat itself in a strong economic recovery.

It doesn't matter whether a company is big or small. Capital structure matters. It always has and always will.

Mr. Milken is chairman of the Milken Institute.

About the author: I have a broad range of interests in technology, engineering, design, finance and public policy; a BSBA degree in International Marketing from Arizona State University with undergraduate studies in Nuclear Engineering and Architecture from Oregon State University; I have more than 30 years experience in instrumentation and control design and product development.

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