Business: Din of Lies
It has become fashionable to attack the 1980s as a decade of greed, selfishness, and excess. The conventional wisdom: In the '80s a handful of would-be robber barons and junk-bond salesmen looted corporate coffers, leaving employees jobless and investors holding worthless paper. And the criminal mastermind behind much of this looting was junk-bond pioneer Michael Milken.
Everyone from Spy to congressional leaders has taken shots at Milken, blaming him for everything from the S&L crisis to homelessness. James B. Stewart, the page-one editor of The Wall Street Journal, sums up the popular wisdom about Milken and the 1980s in his book Den of Thieves.
Rather piously, Stewart begins with the Word: expulsion of "all them that sold and bought in the temple, and overthrew the tables of the moneychangers and the seats of them that sold doves" and "ye have made it a den of thieves." Then there is a quick recitation, chapter and verse, of the conventional wisdom on bust-up, shut-down junk-bond takeovers, and a warning that we could risk missing the big picture. During this crime wave, the ownership of large corporations changed hands, often forcibly, at a clip never before witnessed. Thousands of workers lost their jobs, companies loaded up with debt to pay for the deals, profits were sacrificed to pay interest costs on the borrowings, and even so, many companies were eventually forced into bankruptcies and restructurings.
No facts, no figures, no presentation of economic evidence for many of the supposed crimes against mankind and the U.S. economy. Such is the case against Milken, junk bonds, and the 1980s. Let us, then, consider the evidence.
While ownership change in the 1980s was extensive and fast, it was not, as the conventional wisdom expressed by Stewart would have it, "at a clip never before witnessed." In each year of the 1980s there were approximately 2,000 deals. By comparison, between 3,000 and 6,000 deals were done each year during the 1967–1974 merger-and-acquisition wave.
The deconglomeration wave of the 1980s, which undid inefficient and poor acquisitions of decades past, was hardly sweeping. The leveraged-buyout wave affected only 12 percent of U.S. firms. At its peak in 1985, the junk-bond market had extended credit to fewer than 2,000 firms previously excluded from the capital markets.
The merger waves of 1898–1908 and 1922–1930 each represented a larger proportion of total corporate assets than the restructurings in the 1980s. In fact, in the 1980s, aggregate industrial concentration of sales, employment, and assets actually declined.
Those who attack the 1980s also hold that the buyouts forced debt-laden companies to lay off workers. But the last few years have produced considerable evidence to the contrary. A Bureau of Labor Statistics review of mass layoffs and plant closings found that only 4.4 percent of layoffs and plant closings and 6.6 percent of total jobs lost in the 1980s were cut as a result of business-ownership change.
Using plant-level census data tracking 1,100 manufacturing plants involved in ownership change during 1986–1988, my colleagues and I at the State University of New York at Stony Brook found no evidence that firms that restructured their ownership or finances were more likely to eliminate jobs or shut down factories than others. Detailed studies in New York, New Jersey, and Michigan over the same period found that less than 2 percent of total job loss occurred in firms involved in ownership change or the junk-bond market.
In fact, industries that lost jobs because of foreign competition lost fewer when junk bonds were an element of restructuring. In those declining industries, firms in the junk-bond market retained greater market share and more jobs than their counterparts. After restructuring or new financing, firms actually reversed the patterns of job loss.
During the 1980s, our study showed, firms financed in the noninvestment-grade market experienced job growth at six times the rate of industry overall.
Not surprisingly, then, the end of job creation in America has closely tracked the collapse of the junk-bond market; there have been no new jobs created since 1989. When expansion in the noninvestment-grade growth sector slowed, the largest corporations lost customers, distributors, and suppliers. Without those sources of demand, the Fortune 500 continue to do what they had done in the 1980s: accelerate write-offs and layoffs.
Credit did get more creative, and accessible, in the 1980s. The absolute level of corporate debt creation—the hockey-stick graph we usually see when this story runs in the business press—has increased 12 percent annually since 1983, at a rate one-third faster than in the 1970s.
But credit risks are analyzed relative to something—such as assets, short- or long-term debt, sales, or net interest as a share of gross cash flow. Most of these measures show relatively little change compared to earlier periods of economic expansion. Credit, therefore, essentially leveraged and supported other elements of a corporation's finances to sustain equity growth.
Most attacks on the '80s omit the facts about bankruptcies and defaults. We know that two-thirds of the distressed credits in the junk-bond market were deals done after 1987, when Michael Milken was, for all practical purposes, benched by the government's investigation. At that time, he was telling anyone who would listen that it was time to deleverage because the cost advantages of debt relative to equity were beginning to reverse.
But with the shutdown of the junk-bond market in the late 1980s, deleveraging was not possible for many companies. Panic selling in the capital markets, tax and regulatory changes, and fear about "junk" companies froze the capital structures and made debt restructuring impossible. As the economy began to contract, companies couldn't pay off debt or sell assets, reverse their growth strategies, or control their cash flow.
Even though default rates of junk-financed companies after 1987 nearly tripled, the number of distressed firms was still only about 10 percent of the total market. Equating the junk-bond market—and Michael Milken's leading role in its development—with the thieving and looting crimes of a few individuals gives the wrong impression, since the numbers simply don't add up.
What really went wrong? We have to go beyond economics to politics and its role in restraining competition. Also pertinent is why economic pioneers who knowingly or not go against established interests sometimes end up fighting range wars with the big ranchers entrenched in corporate headquarters and government agencies.
Prior to the junk-bond market ascendancy, which paralleled the restructuring movement of the 1980s, less than 5 percent of all U.S. companies accessed more than 95 percent of the available public capital, restricting it to big business. Yet many large companies, stuck with spotty economic returns, were disinclined to create new products and increasingly preoccupied with strategic thinking about unloading assets and employees.
These large companies with high credit ratings carried relatively little debt, so their cost of capital was higher than for their Japanese and West European competitors, who were flourishing in U.S. markets and, in turn, helping to eliminate American jobs.
Also, the continuing separation of ownership and control in corporations had created a situation in which the management of the nation's largest businesses owned less than 1 percent of the common stock of their own companies. This led to entrenchment strategies that increased executive compensation, perks, and empire building.
Paradoxically, the companies with the highest returns on capital, fastest rates of market-share and employment growth, and greatest contributions to technological and new-product innovation had the least access to capital. Into this market niche stepped Milken, who, following the tradition of Western movement in U.S. history, lit out for California, built a business, hit the mother lode, and struck it rich.
Until the junk-bond market came along, banks had a headlock on the more-innovative mid-sized American businesses. When the junk-bond market expanded in the 1980s, firm owners and managers leapt at the chance to gain access to growth funds. In a few short years, the junk-bond market generated business loans far in excess of the whole commercial banking sector. Supplying the lowest-cost and most flexible source of capital generated a great deal of money and helped to shift the balance of economic power.
During the 1980s, the logic of extending economic participation through ownership expanded beyond the traditional arenas of housing and agriculture to businesses. New technologies and innovation invigorated newly restructured firms. Moreover, the benefits of corporate restructuring—expanding access to capital, ownership change, and alternative ownership patterns (ESOPs, MBOs, minority- and women-owned firms), and accompanying productivity changes—were the key elements in the surprising junk-bond revolution.
The junk-bond market was a real threat to those 5 percent of companies that had been feasting on 95 percent of the available public capital. Sadly, big business sought and got the retrenchment policy measures that helped bring on the lingering recession.
In retrospect, the restructuring wave of the 1980s has paid off. From 1978 to 1988 the percentage of firms mining a single business segment with increasing success rose from 35.6 percent to 54.3 percent. The trend toward better focus was associated with significantly higher returns to shareholders, improved market share, and better accounting measures of firm performance.
Beyond the $200-billion junk-bond market of the 1980s, other investment markets flourished: venture capital, initial public offerings, and private placements that together peaked at over $466 billion in 1986. Had those investment levels continued through 1990, the economy's capital stock would have grown by $247 billion; nearly 1 million of the jobs lost over the past two years would have been retained; and by conservative estimates, growth firms would have added roughly another 1.6 million jobs. There would have been business-cycle adjustments and market corrections—not one long recession.
On June 26, 1991, as Den of Thieves went to the printer, The New York Times ran a front-page story, "A Revival is Seen for 'Junk Bonds' as Market Gains." Despite the taint of negative press, plummeting bond prices, and a regulatory backlash, the market for business loans called junk bonds has roared back from its October 1990 low to a gain of 40 percent. But the market's own phoenix-like redemption does not mean that the growth and expansion of capital access to include more firms, communities, and industries is right around the corner. It won't be, so long as the redlining of American business continues.
Glenn Yago is the director of the Economic Research Bureau at the Harriman School for Management at the State University of New York, Stony Brook, and author of Junk Bonds: How High Yield Securities Restructured Corporate America (Oxford University Press).