MCI, Disney, News Corporation, RJR Nabisco, Revlon, Wynn Enterprises, Mattel, Viacom, TCI Cable, Time Warner, Barnes & Noble, CNN. Each of these corporations owes its existence and rise to greatness to one innovation. In fact, this one innovation completely turned around the American economy, spurring the second-largest, sustained growth in the twentieth century. More impressively still, this innovation was the product of one man. The innovation? High-yield bonds—or junk bonds, in common parlance. The man? Michael Milken.
High-yield bonds have been around since bonds had come about. A high-yield bond is simply a debt instrument that must carry a higher rate in order to attract buyers, usually because the issuing company has fallen on hard times. At least, that is the presumption behind the subpar ratings given the bonds by standard rating agencies like Moody's or Standard & Poor's. Michael Milken, while still in college, had chanced upon a comprehensive study by Braddock Hickman of the corporate bond market from 1900 to 1943. After careful perusal, Milken realized that most of the downgraded bonds studied had actually been safer and more profitable than the so-called triple A-rated bonds.
And that is where Milken found his niche. His task was to persuade investors that junk bonds were a profitable, safe investment. The obstacle he had to overcome was the ratings agencies. A lower than triple A mark sent the institutional investors—such as pension funds, insurance companies, and banks—running. Through voluminous knowledge and research, he was able to convince bond buyers that junk bonds were really underdogs depressed by complacent bond rating companies and not the dregs of the American economy.
In the beginning, Milken sought to create a market for these junk bonds—breathing liquidity into an otherwise staid instrument; he was at the nexus of buyers and sellers of non-investment grade debt. Cut off from underwriting by a brokerage house and faced with intolerable interest rates from banks or dilution of ownership through stock issues, the junk bond was the only option available to a company that had encountered the disdain of a bond rater. If investors knew they could find a seller when their nerve wavered, the junk bond lost its unseemliness. Milken provided them the assurance that, if no one else would buy it, either he or his firm—Drexel Burnham Lambert—would. Given Milken's charisma and Drexel's rising stature, this was no small guarantee.
After establishing a junk bond trading network, Milken moved on to more lucrative and substantial feats. Rather than simply buying and selling securities, he wanted to create them. That is, he wanted to move Drexel from a third-tier Wall Street firm to the top of the industry. He sought to finance the growing merger frenzy; he wanted to expand the economy by funding its ablest corporations; he wanted to showcase the power of the junk bond. He did this by finding upstart, well-managed companies and providing them with more than enough financial capital to achieve their wildest desires.
Often, their wildest desires included purchasing bloated, inefficient conglomerates. The sixties and seventies have been characterized as decades of consolidation. Huge corporations like ITT and Beatrice Foods were created from a diverse spectrum of smaller companies. At the time, this made sense because of the economies of scale in management. However, by the eighties, these conglomerates had become inefficient and unwieldy. The so-called "corporate raiders" financed by Milken's junk bonds served an important function: shaking up complacent businesses either by takeover or threat of takeover.
At the opposite end of the upstarts' dreams were the expansionist companies. These corporations were spectacularly undercapitalized and in desperate need of Milken's creative means of financing. They had great ideas and enormous potential but were trapped by the establishment's fear of change and risk. Milken had no such phobia and eagerly arranged for the funding of their goals. For example, MCI was regularly laughed out of Wall Street firms for its incredible dream of challenging AT&T's dominance in long-distance calling. Milken saw its potential and coordinated $1 billion initially and $3 billion eventually in order for MCI to construct the fiber-optic network AT&T had passed over. The current status of MCI vis-à-vis AT&T need not be mentioned. Similarly, when Ted Turner envisioned a news channel with 24-hour-a-day coverage, he was shunned. That is, until he came to Milken. Milken got Turner $100 million in junk bonds which helped Turner to establish the informational powerhouse that CNN is today.
Such innovation is central to the American economy and, more fundamentally, the American way. Every facet, every aspect of our daily lives has been profoundly impacted by the efforts of the "vital few," entrepreneurs whose vision and drive impelled them to produce. The computer on which I am typing this essay was the product of Steven Jobs' relentless pursuit of building the best computer. The light by which I work was the result of Thomas Edison's boundless curiosity. I could not have created such items. But in a capitalist society, I do not have to. I need only create enough wealth through my own labor in order to compensate them for their's. We each trade with the other to mutual benefit.
American history is littered with tales of the great industrialists of yesteryear. Andrew Carnegie, John D. Rockefeller, James J. Hill, J.P. Morgan. The common bond between them is the innovative nature of their minds. Carnegie organized capital and labor into the most efficient system of production of steel. Rockefeller revolutionized the production and delivery of oil. Hill created a financially responsible railroad without government subsidization. Morgan created a new method of organizing and financing businesses.
Michael Milken was the latest in a long chain of revolutionary innovators.