By Kevin D. Williamson
Sunday, February 23, 2020
With Donald Trump’s pardon of former financier Michael
Milken, the term “junk bond” has been back in the news — Milken invariably is
referred to as “the junk-bond king.”
You may know that Milken spent the Eighties, Ronald
Reagan’s great wicked “Decade of Greed” — engaged in “insider trading,” a crime
for which he went to prison at the end of that gaudy decade. Everybody knows
that. It isn’t true: Milken was never convicted of insider trading but
of crimes that were “technical securities violations and did not directly
enrich him,” as the New York Times editorial put it at the time. What everybody
knows is, to some extent, a legend and a fabrication, one more informed by
cinema’s Gordon Gekko than by the actual crimes of Michael Milken — but
everybody “knows” it, anyway.
Most people could not explain to you what “insider
trading” really is, or tell you why it is that financial transactions
that may be crimes in the United States generally are not (but sometimes are)
in Europe and much of the rest of the world. Most people couldn’t tell you
what a “junk bond” is, but they know that these are bad, bad, bad. I once spent
a very amusing afternoon walking around the filth and dueling psychoses of
Occupy Wall Street asking the people who wanted to ban derivatives to tell me
what a derivative is, or to explain what it is that a private-equity firm does,
or how investment banks make their money. Of course practically nobody knows,
and there is no real reason they should — rational ignorance, and all that. It
may be that people in a state of nearly pristine ignorance about x
should be circumspect in their opinions about the regulation, taxation, or
outright prohibition of x, but they aren’t, and that’s democracy for
you.
One of the largely forgotten bits of trivia from the
Eighties — one that remains relevant today, with or without Michael Milken’s
being in the news — is that those “junk bonds” Milken championed turned out to
be . . . pretty good investments.
“Junk bonds,” or high-yield bonds, are what you get when
people who make their money lending to businesses provide that service to firms
that do not have good credit, i.e., businesses that are distressed or
restructuring, businesses that have recently suffered some kind of setback,
etc. The old bankers’ proverb advises that the last person you want to lend
money to is somebody who needs money, and the same principle holds true for
companies. Apple, which is sitting on $250 billion in cash, along with its
other assets, recently went to the markets to borrow some cash. Because Apple
doesn’t actually need money, it can borrow very cheaply and easily at low
interest rates, and so sometimes it makes more sense to sell bonds (which is
how companies such as Apple borrow large sums) rather than break open its own
piggy bank. Nobody is worried about Apple’s being able to repay its
bondholders.
But that is not true for lots of other companies.
Companies with less healthy businesses, less revenue, less cash on hand, or
less obviously promising business prospects have to offer creditors higher
interest rates in order to secure financing. The very riskiest class of bonds
are colloquially known as “junk,” and junk bonds pay very high interest rates.
Businesses issuing these bonds also default on their bonds more often than do
companies such as Apple. That’s familiar stuff: higher risk, higher reward. The
theory of junk bonds is that if you buy a reasonably diversified portfolio of
them, then the higher interest rates you earn will more than make up for the
higher rate of default you can expect. And that is often how things work out.
Not always, of course: If there weren’t any risk, there wouldn’t be any reward.
Junk bonds are not for everybody. Ordinary commercial
banks, for example (the kind with FDIC guarantees where regular people have
checking accounts), are required to keep their capital in “investment-grade”
assets, which excludes junk bonds. That makes sense. Also, your Aunt Sally, a
retired schoolteacher with no source of income other than Social Security and
her savings, probably shouldn’t put her entire nest egg into junk bonds, even
if her brother-in-law tells her it’s a can’t-lose investment. (If you think you
have a foolproof investment, you are the fool.)
But if you are a big, complex financial institution, or a
very wealthy person or institution, then a few high-yield bonds in your portfolio
might be a good idea: It makes sense for such investors to diversify not only
the kinds of assets they hold but their risk profiles, too. But these kinds of
investments are by their nature highly volatile, which is fine — for a certain
kind of investor. If you have 2 percent of your $3 billion portfolio in highly
volatile high-yield bonds, you may not enjoy watching them do what volatile
investments do, but you have the wherewithal to ride out that volatility — and
you knew it was coming, so you expected it and planned for it. If you need that
money next week to make the mortgage payment, then junk bonds are not for you.
Junk bonds are an ordinary and noncontroversial part of
life for modern financial professionals. In the case of Milken’s infamous junk
bonds, investors who held on to them rather than selling in a panic when
volatility hit did well. The “junk bonds” did exactly what they were supposed
to do: They connected those lenders who had a higher tolerance for risk with
borrowers who couldn’t get financing on other terms.
Sometimes, companies that are involved in very innovative
(and hence risky, or risky-seeming) lines of business turn to high-yield debt
markets. Milken’s firm famously helped build MCI, which went on to be a
telecommunications giant and Internet pioneer, one of the first large-scale
email providers in the United States, among other things. MCI ended up being
acquired by WorldCom, which became a byword for corporate scandal. Tesla tapped
the high-yield debt market in 2017. Of course there is crime in finance — there
is crime in everything, from church to state. The sort of people who say that
Michael Milken’s career is an indictment of capitalism never argue that Rod
Blagojevich’s career is an indictment of democracy. They are predictable that
way.
The 2020 Democratic primary field is big on denunciations
of Wall Street and “corporate greed.” Not Michael Bloomberg so much: As Paul
Krugman summarized the Democrats’ conventional wisdom in the New York Times,
Bloomberg didn’t make his fortune through Milken-style wheeling and dealing,
but instead “he got rich by selling equipment to destructive wheeler-dealers.”
Professor Krugman argues that the Democrats should talk more about
“financialization,” another instance of terminology masquerading as an idea.
Professor Krugman flatly asserts that Bloomberg’s business is not “good for the
economy,” that it does not “do anything significant to improve real-world
business decisions that affect jobs and productivity.” Professor Krugman is in
fact a skeptic of the value of much of what the financial-services industry
does. He is, like Tucker Carlson and others who offer similar complaints, a
nostalgist. He writes:
During the U.S. economy’s greatest
generation — the era of rapid, broadly shared growth that followed World War II
— Wall Street was a fairly peripheral part of the picture. When people thought
about business leaders, they thought about people running companies that
actually made things, not people who got rich through wheeling and dealing.
The people who sell junk bonds find value in them: They
want the cash. The people who buy junk bonds find value in them, too: They want
the return. Who is Professor Krugman — or, more to the point, who is Senator
Sanders — to stand between them wagging his finger? Modern business enterprises
rely heavily on sophisticated and efficient financial services. It seems to me
almost certain that the people at Apple are in a better position to judge their
financial need and the best way to satisfy them than Senator Sanders is.
But when it comes to Wall Street, like so many things in
our politics, the fight isn’t really about the thing the fight pretends to be
about. “Wall Street” is not a place in Manhattan or the businesses that are
(and traditionally were) headquartered in the neighborhood. It is a vapor of
anxiety and resentment, a shorthand for the incomprehensible complexity of
modern business life that has its uses in the imbecilic politics of our time
and in the vast apparatus of self-moronization that enables that politics.
The most simpleminded kind of politics requires a
villain. The Democrats would very much like to present the November election as
being, in spirit, a choice between Senator Sanders and Michael Milken. Given
the choices on offer, the conclusion there is obvious enough.
Milken 2020.
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