On Monday, October 19, 1987 (known as “Black Monday”), the Dow Jones Industrial Average (DJIA) plunged 22.6%. The DJIA’s collapse greatly surpassed its 12.8 percent single-day drop on Black Thursday of October 28, 1929. Out of twenty-three major industrial countries, nineteen had a decline greater than 20%. Worldwide losses were estimated at $1.71 trillion. The severity of the crash sparked fears of extended economic instability or even another Great Depression.
The market was due for a correction. In the five years preceding October 1987, the DJIA more than tripled in value, creating excessive valuation levels and an overvalued stock market. But, the downturn was exacerbated by “program trading”, automatic computerized buy/sell orders when market levels reached certain points. In program trading, human decision-making is taken out of the equation, and buy or sell orders are generated automatically based on the price levels of benchmark indexes or specific stocks.
These computer programs automatically began to liquidate stocks as certain loss targets were hit, pushing prices lower. Program trading led to a domino effect as the falling markets triggered more stop-loss orders. The frantic selling activated yet another round of stop-loss orders, which dragged markets into a downward spiral. Since the same programs also automatically turned off all buying, bids vanished all around the stock market at basically the same time.
The greatest danger to the economic system presented by the “Black Monday” meltdown was the possibility of the failure of securities firms and investment banks. Financial pressure was put on these firms when they had to meet calls to pay off money they had borrowed to finance their stock trading operations (“margin loans”). The value of their stock holdings had plummeted and could not support the loans. They did not have capital reserves to meet the margin calls. Banks were not willing to extend more credit.
One day after the crash, the Federal Reserve began to act as the lender of last resort to counter the crisis. It immediately began injecting its reserves into the financial system via purchases on the open market. On October 20 it injected $17 billion into the banking system through the open market. The Fed continued its expansive open market purchases of securities for weeks. It took two years to recover from Black Monday. It wasn’t until 1989 that the DJIA finally recovered what was lost in one day 2 years prior. In 1987 the DJIA only gained 0.6% on the year. After this crash, the Federal Reserve and stock exchanges intervened by installing mechanisms called “circuit breakers,” designed to slow down future plunges and stop trading when stocks fall too far or too fast.
A recession was not directly caused by the 1987 crash. However, the incident set the stage for two more economic crises: the savings and loan crisis of 1989 and the recession that occurred between 1990 and 1991.
“Greed is Good” – Wall Street in the 1980s
1980s America has been described as being a “[c]ulture of money and glitz… [It was a time when] wealth and its excesses became a public fascination, a raucous burlesque show that paraded across the national stage.” (Century, p. 480) ‘‘Wealth is back in style,’’ declared U.S. News & World Report
More millionaires were created during the 1980s than any period since the days of The Robber Barons at the turn of the 19th century. Forbes published its first list of the 400 hundred wealthiest people in the world. The hottest syndicated show on TV in the early eighties was Lifestyles of the Rich and Famous. “Lifestyles” was a shameless celebration of pure, unadulterated materialism. ‘‘For whatever sociological reasons,’’ wrote Newsweek in 1984, ‘‘the ebb and flow of the lumpen’s fascination with the rich has hit a historic high.’’
No other single event symbolized 1980s wealth more than Malcolm Forbes’s (Forbes Magazine) seventieth birthday party. Forbes had spent $2 million on an anniversary bash for his magazine at his New Jersey estate just a couple of years before, but for this occasion, New Jersey just wouldn’t do. 800 handpicked guests and 110 reporters were off to Palais Mendoub, Forbes’s Moroccan palace, previously occupied by a sultan (and his multiple wives). Except for a few guests who flew over in private jets (Lee Iacocca, Calvin and Kelly Klein, and Liz Taylor, who hopped a ride in the host’s own plane, the Capitalist Tool), three planes—a Concorde, Boeing 747, and DC-8—whisked the ‘‘Forbes 800’’ from JFK Airport to Tangier. Nibbling on their in-flight meal of Cornish hen and brownies direct from Le Cirque (Concorde passengers gulped down salmon, lamb noisettes, potato pancakes, and chestnut mousse during the three-hour-and-eighteen-minute flight), the who’s who of who’s who (including Barbara Walters, Katherine Graham, Helen Gurley Brown, Diane von Furstenberg, Donald and Blaine Trump, Nan Kempner, and Henry Kissinger) were welcomed by hundreds of locals, who clapped, danced, and blew horns. ‘‘Black tie, ball gowns, turbans, and tiaras are all in order for an evening of exotic dancing and fireworks,’’ the invitation read, recalling the famous 1951 party in Venice thrown by the international man of mystery. Overlooking the Straits of Gibraltar, partiers supped on 100 barbecued lambs, 830 chickens, and a desert of couscous, entertained by 200 horsemen and 750 performers personally provided by King Hassan II. As a finale, Beverly Sills sang ‘‘Happy Birthday’’ to Ali-Dada, as Forbes called himself for the evening, followed by sixteen minutes of fire-works accompanied by ‘‘Bolero.’’ As guest Rupert Murdoch had put it as a headline in his London tabloid Sun, “EITHER YOU’RE THERE OR YOU’RE NOWHERE”
“…[T]he eighties were the decade of the ‘paper entrepreneurs’, lawyers and bankers who made their money, not by building or selling anything, but by shifting and manipulating deeds of ownership, by repackaging or remortgaging or even dismantling companies – deal makers interested not so much in making things as, in a sense, unmaking things, rearranging things, and putting things back together. (Century, Id., emphasis in original)
“Unlike other periods of Republican prosperity, this economy was fueled not by the pursuit of the better mouse trap or even of the better advertisement to sell an existing mousetrap (as might have been the goal, perhaps, in the Fifties) but by organizing a leveraged buyout of a mousetrap company and merging it with a company that made something of related importance, like, say, cheese.” (Id.)
Mergers and acquisitions activity (leveraged buyouts – LBOs) were the vehicles used by Wall Street gurus to make themselves mega rich. Corporate raiders sought out undervalued, target companies – corporations that could be bought cheaply- purchased them using complicated financing transactions involving borrowed money, broke the companies up into parts, and sold the individual parts at significant gain. These transactions left workers, who counted on retiring from the company with a pension, without jobs and benefits, but greatly benefiting the managers and shareholders, who got golden parachutes and stock appreciation.
Unlike a traditional takeover where an acquiring company needs a lot of its own funds to buy a target company, the acquirer in an LBO borrows (“leverages”) almost all of the money needed to buy the company. Traditionally, 60 percent of the money raised in an LBO came from secured debt loaned by commercial banks. Only about 10 percent came from the buyer’s own pocket, and the remaining 30 percent came from major insurance companies, whose commitments often took time to obtain. However, at the time, junk bonds (highly risky bonds which promise to pay the holders very high interest rates) were extremely popular among investors, and so it was very easy to raise huge amounts of cash. The debt used to buy the shares is assumed by the company and is paid down over time, using cash flow from the company’s operations and, often, by selling pieces of the business.
Big time brokerages that put together the LBOs included Goldman Sachs, Kohlberg, Kravis and Roberts (“KKR”), Drexel Burnham Lambert, Merrill Lynch, Morgan Stanley, Wasserstein Perella & Co., Forstman Little & Co., and Shearson Lehman and Hutton. Prominent corporate raiders of the 1980s included Ivan Boesky, Michael Milken, Carl Ichan, Martin Siegel, and T. Boone Pickens.
Michael Milken – the quintessential Wall Street “Master of the Universe”
Michael Milken was an American financier whose “junk-bond” operations at Drexel Burnham and Lambert fueled many of the corporate takeovers of the 1980s. His nickname was “Junk Bond King”, based on his perfecting the use of junk bonds as the financing device for corporate takeovers. Milken’s compensation while head of the high-yield bond department at Drexel Burnham Lambert in the late 1980s exceeded $1 billion over a four-year period, a record for U.S. income at that time. At the height of his success, Milken earned between $200 million and $550 million a year. He was the highest-paid man in Wall Street history.
“Junk bonds” are debt securities issued by corporations with less than stellar balance sheets. They give companies with questionable credit ratings access to capital. Due to the poorer credit ratings of the issuing entities, junk bonds were regarded as more liable to default and hence were considered too risky by the large institutional investors. Junk bonds earned substantially higher rates of return than did investment-grade bonds.
Milken acknowledged that buying bonds from companies with low credit standing was a significant risk; but, he argued, if you cast the net wide enough, the odds would stack in your favor. Why make one expensive investment with low interest rates in a ‘safe’ institution when you could make a killing buying bonds in ten companies deemed to be on the brink of insolvency?
Milken’s vast and powerful junk-bond network fostered the “merger mania” of the 1980s, in which his clients, partners, and allies, among others, engaged in a wave of corporate mergers, acquisitions, hostile takeovers, and leveraged buyouts. By the end of the 1980s, the junk-bond market had grown to $150 billion in size, and Drexel Burnham had become one of the leading financial firms in the United States.
One of the ways that Milken marketed his junk bond operation was via the ironically titled “The Predator’s Ball”, an event that Drexel Burnham hosted annually for the purpose of matching high-risk companies searching for financing with investors who wanted the high rewards that can come with higher risk. Among the participants in the Predator’s Ball were an array of private equity investors, corporate raiders, as well as institutional investors in high-yield bonds and management teams from companies that either had been or would be the targets of leveraged buyouts.
Although the annual conference was noted for extravagance and lavish entertainment that included Frank Sinatra, Diana Ross and Dolly Parton, the real purpose was to conduct business. Corporations that raise capital by issuing junk bonds put on presentations to institutional investors who buy them. Big companies in a single meeting get to make a presentation to what was undeniably the biggest assemblage of junk bond buyers. And there were similar chances for the “Cinderellas” at the junk bonds ball–the small, upstart companies–to make a pitch for the money that could mean big expansion and success. In the side rooms and hallways, Drexel employees stand by to sign up deals.
Milken was indicted for racketeering and securities fraud in 1989 in an insider trading investigation. As the result of a plea bargain, he pleaded guilty to securities and reporting violations but not to racketeering or insider trading. Milken was sentenced to ten years in prison, agreed to pay $200 million in fines, paid $400 million to investors who had been hurt by his actions. and was permanently barred from the securities industry by the Securities and Exchange Commission. In a related civil lawsuit against Drexe,l he agreed to pay $500 million to Drexel’s investors. His sentence was later reduced to two years for cooperating with testimony against his former colleagues and for good behavior. The Time Magazine cover headline after Milken’s plea read “Predator’s Fall”. Drexel itself agreed to plead guilty to six felony counts and pay $650 million in penalties on charges of securities fraud and defrauding customers. On February 18, 2020, President Donald Trump granted Milken a full pardon.
Mike Milken”, Capitol Steps, available on the “Fools on the Hill” album, not available for download due to copyright restrictions, excerpt can be found at https://madmusic.com/song_details.aspx?SongID=7023
OK, man, we’re trying to do a little song about the Wall Street Man
It’s JamaIcan, like in “how much you Jamaican”
So please welcome Mr. Harry Billoffortune
Let me sing about the crooked Wall Street punk
Who got himself in jail for selling bonds of junk
Mike Milken, he takes the money and he goes to the jail (repeat)
Ivan Boesky
Ivan Boesky battled Michael Milken for the title of the most notorious Wall Street financial villain of the Reagan Years. (See reference to Boesky “Greed is good” speech.)
Boesky’s specialty was stock arbitrage, which is a term that describes when stock traders try to exploit market inefficiencies, such as when a trader believes one company’s stock has been undervalued. Arbitrage traders often buy up big chunks of stock in a company on the bet that the price will jump, especially if that company is on the verge of being acquired. It can be a big gamble, especially if a takeover falls through or the company’s stock drops for any other reason.
Boesky started his own arbitrage firm in 1975. Throughout the early 1980s, Boesky, working as an arbitrage specialist and known as “Ivan the Terrible,” amassed a fortune estimated at approximately $200 million by betting on corporate takeovers and mergers. Boesky took advantage of the gap between public and private market values to raid corporate targets; the practice was within the law as long as the trading in the targets’ securities was based on public knowledge of the imminent acquisitions. But Boesky received inside information regarding potential takeover targets from the likes of Michael Milken, Dennis Levine and Martin Siegel. He had acquired securities in various companies on the basis of those tips, often making significant purchases just days before a corporation publicly announced a takeover.
One such exchange of insider information is described in Bill Taylor’s February 1992 Harvard Business Review article “Crime? Greed? Big Ideas? What Were the ‘80s About?”:
It is January 1983, and Martin Siegel is in the lobby of New York’s Plaza Hotel. Siegel, while only in his mid-thirties, is already one of Wall Street’s most celebrated dealmakers, having become a full vice president of Kidder Peabody just three years after joining the firm in 1971. By 1983, he is Kidder’s highest paid officer and the inventor or perfecter of some of Wall Street’s most creative takeover maneuvers. But Siegel is not at the Plaza for lunch with a prospective client or to strategize some new takeover defense. At an appointed time, a courier clutching a briefcase walks by Siegel and softly says, “Red light.” Siegel takes the cue and responds, “Green light.” The briefcase changes hands, and Martin Siegel goes home. There, in his Upper East Side apartment, he opens the briefcase and finds stacks of crisp, neatly wrapped $100 bills. Through one illicit stock tip to Ivan Boesky (which will be followed by many more), this already rich man becomes $150,000 richer.
Eventually, Siegel provided Boesky with illegal inside information on deals that Boesky admitted made him more than $33 million in profit between 1982 and 1986. In return, Boesky paid Siegel roughly $700,000 in “bonuses” for those tips.
Boesky and Michael Milken have been described as “two of this country’s most audacious white-collar outlaws.” The Two Faces of Greed, By David A. Vise and Steve Coll, Washington Post, September 29, 1991) Their relationship was described as follows:
These fortunes were made possible in part by complex alliances Boesky and Milken formed on Wall Street. The overall purpose of the alliances was to create wealth through corporate takeovers and other deals. Success in this enterprise depended ultimately on the SEC, which enacts, interprets and enforces detailed rules of the takeover game. Each could have made money, and did, without breaking the law. But what distinguished the alliances formed by Boesky and Milken during the 1980s, the SEC eventually concluded, was their dependence on systematic fraud and illegality.
(Id.)
Boesky’s illegal deals made him one of the richest men on Wall Street. At the peak of his investment business, Boesky was overseeing an investment fund with over $3 billion in assets, and he had a net worth of more than $200 million (more than $475 million in 2020 money) and a place on the Forbes 400 list of America’s wealthiest people.
However, the Securities and Exchange Commission (the SEC) uncovered evidence against other Wall Street malefactors, who blew the whistle on Boesky. He was arrested in 1986 for insider trading. Boesky paid $100 million in penalties and served three years in prison for betting on corporate takeovers using inside information and illegally manipulating the stock. He was also barred by the SEC from the world of trading, and acted as a government informant on other financial industry malefactors, including Milken.
Following the trading scandals of the 1980s, Congress increased the penalties for securities violations when it passed the Insider Trading Act of 1988.
Lincoln Savings, Charlie Keating and the S & L Crisis
The Savings and Loan (S & L) Crisis of the 1980s and 1990s was the largest banking crisis after the Great Depression up to that time. The S & L Crisis resulted in the failure of nearly a third of the 3,234 savings and loan associations in the United States between 1986 and 1995. The estimated cost to taxpayers, not counting the interest payments on government bonds sold to finance the industry’s bailout, was between $150 to $175 billion. If interest over the next thirty years was added to this tab, the cost approaches $ 200 billion, $132 billions of which was borne by taxpayers. (“Crimes of the Rich and Infamous”, Calavita, p. 1)
Lincoln Savings and Loan, owned by American Continental Corporation and run by Charles H. Keating, Jr., a Phoenix real estate developer, was the symbol of the crisis. Lincoln Savings represents an example where the pursuit of profit by a corporation along with the failure of state agencies to effectively monitor the institution’s activities resulted in a host of criminal activities. (For a discussion of other S & L operators who looted their institutions, see Calavita, pp. 23-32)
The modern savings and loan industry arose out of the banking crises of the Great Depression. The Savings and Loan industry was created by the Federal Home Loan Bank Act of 1932, Home Owner’s Loan Act of 1933, and the National Housing Act of 1934. In contrast to traditional banks, S & L’s (sometimes called “Thrifts”) primary purpose was to encourage savings by the populace so that they could buy houses. S & Ls financed long-term mortgages with short-term savings deposits. In order to encourage such savings, the federal government instituted the FDIC (Federal Deposit Insurance Company), which insured S & L deposits up to legislated amounts.
The interest rates paid by S & Ls were regulated by the federal S & L administrators. This limited the ability of S & Ls to compete with traditional lenders for deposits and loans. As savers deposited money into newly created money market funds that paid increased interest in the early 1980s, S & Ls could not compete with traditional banks for deposits. The inability of S & Ls to attract deposits led to a fear that the S & L industry would collapse.
To remedy this competitive disadvantage, regulators, encouraged by Reagan Administration policies, allowed Thrifts to take on more free market characteristics. Thrifts were allowed to offer higher interest on deposits, to offer adjustable-rate mortgages and to make new, riskier kinds of loans, not just residential mortgages. The FDIC guaranteed higher amounts of deposits, raising the amount from $40,000 to $100,000. This increased the number of deposits in S & Ls and the amount of money that could be used for newer, riskier loans. From 1982 to 1985, thrift industry assets grew 56 percent, more than twice the 24 percent rate observed at banks. But, the S & L regulators did not make any changes in the FDIC insurance program, meaning that S & Ls could make riskier investments without increased fear of loss. In the early 1980s, S & Ls started to make speculative investments relying on the federal insurance. The taxpayers took on all the risks.
During this period some aggressive S & Ls joined the finance industry generally, using the junk bond industry and savings and loans together. When Charles Keating decided to buy a savings and loan, he went to Drexel, Burnham, Lambert’s (Drexel) junk bond chief, Michael Milken, who engineered the sale of junk bonds that financed Keating’s $50 million purchase of Lincoln – twice the market value of the S & L. Allowing a real estate developer to be in charge of a S & L proved to be disastrous. Soon after buying Lincoln, Keating’s S & L virtually stopped making loans to families to buy homes and began using depositors’ money to buy junk bonds from Drexel. Lincoln used the junk bond proceeds to finance risky commercial real estate deals such as Leveraged Buy Outs (“LBOs”). Some of Keating’s Lincoln Savings real estate development deals that went “bust” included the Phoenician Hotel, Scottsdale, AZ, the Estrella Subdivision, Goodyear, AZ, Rancho Vistoso, Tucson, AZ, and the Hotel Pontchartrain, Detroit, MI.
Not only did Lincoln Savings change its lending practices, it engaged in seriously questionable business practices. “Government investigators discovered an elaborate web that connected the investment banking firm of Drexel Burnham Lambert, many of Wall Street’s best-known corporate raiders and some of the highest-flying savings and loans. Working closely together, those organizations bought each other’s bonds, gave each other loans, traded securities back and forth, financed corporate takeovers, participated in real estate deals together and sometimes allegedly helped each other create phony profits and evade regulatory requirements, investigators said.” https://www.washingtonpost.com/archive/business/1990/02/18/the-s-l-junk-bond-link/af7c5d43-e4b0-4e24-8c2f-95135a7b041a/
For example, in December 1986, Drexel sold Lincoln 2.1 million shares of stock in Playtex Corp. for 20 cents a share. Four months later Lincoln sold the shares to its parent company, American Continental Corp. (ACC), for $1 a share, a total of $2.1 million. In December 1987, ACC sold the stock to CenTrust Savings for $6.94 a share, or $10.4 million. The following June, ACC bought the stock back for $10.60 a share, or $15.9 million, giving CenTrust a profit of $5.5 million — more than 50 percent gain in six months.
Another common S & L scheme saw two Thrifts conspire with appraisers to buy land using S & L loans and flip it to extract huge profits. Partner 1 would buy a parcel at its appraised market value. The Thrifts would then conspire with an appraiser to have it reappraised at a far higher price. The parcel would then be sold to Partner 2 using a loan from a S & L, which was then defaulted on. Both partners and the appraiser would share the profits. To cite one example, they bought and sold one property worth $50,000 back and forth in the early 1980s until it reached a market “value” of $487,000, whereupon they received a loan based on this inflated collateral. In one major scandal in Ohio, the cooperative bank appraiser (who was never indicted) was known by the nickname “How High Howie.”
In December 1985, Lincoln Savings avoided a S & L regulation known as the equity rule by swapping loans between American Continental and Southmark Corporation, which owned Texas thrift, San Jacinto Savings & Loan. American Continental loaned $129 million to Southmark and its subsidiary, San Jacinto exceeding the loans-to-one-borrower [LTOB] limit. Not only did this net American Continental handsome upfront fees, points, and dividends, but also Southmark returned the favor. Southmark loaned American Continental $35 million for its projects (Calavita, p. 26). Because of loan swapping, American Continental and Southmark exchanged about $246 million in existing mortgages. American Continental booked $12 million in profits from the swaps. (Pizzo, p. 400, Coleman, p. 65)
Moreover, from mid-1987 to April 1989, Lincoln’s assets grew from $3.91 billion to $5.46 billion. During this time, the parent, American Continental Corporation, was desperate for cash inflow to make up for losses in real estate purchases and projects. Keating told Lincoln’s managers to use sophistry to persuade S & L depositors to move their money from federally insured accounts to buy American Continental’s junk bonds, sold by Lincoln Savings (Seidman; 1993, p. 235). The selling technique was bait-and-switch. The employees used the bait-and-switch strictly to deceive investors. Many Lincoln’s members believed that since Lincoln Savings sold the bond, they thought the government backed the bonds with full faith and credit (Coleman; 1994, p. 30). As a result, Lincoln’s personnel illegally sold $250 million of unsecured junk bonds to 23,000 unsuspecting investors, mostly senior citizens living on fixed income (Cope and Talley; 1994, p. 1). FDIC chair L. William Seidman would later write that Lincoln’s push to get depositors to switch was “one of the most heartless and cruel frauds in modern memory.”
Facing federal investigation of Lincoln’s business practices and regulator pressure to close Lincoln, Charles Keating contacted five United States Senators to intervene and stop the closing of Lincoln Savings. Keating called on Senator Dennis DeConcini (D-Arizona), Senator Donald Riegle (D-Michigan), Senator Alan Cranston (D-California), Senator John Glenn (D-Ohio), and Senator John McCain (R-Arizona). Keating asked the Senators to intervene with federal regulators to prevent them from closing Lincoln Savings for its direct investments. He wanted them to protect Lincoln Savings and get the regulators “off his back” (Mayer, 1993; Seidman, 1993).
Since 1984, the Senators received approximately $1.9 million in campaign contributions from American Continental Corporation. Senator DeConcini received $55,000. Senator Cranston received $39,000 for his 1986 campaign, $850,000 for three voter education projects, and $85,000 for a California Democratic Party voter drive. In addition, Senator Cranston received $400,000 for a get-out-and vote fund. Senator McCain received $112,000. In addition, he received nine private plane trips worth $13,433 to the Bahamas from 1984 through 1986. Senator Glenn received $234,000. Senator Riegle received $76,100. (Id. at 68-69)
After a lengthy investigation, the Senate Ethics Committee determined in 1991 that Cranston, DeConcini, and Riegle had substantially and improperly interfered with the FHLBB’s investigation of Lincoln Savings, with Cranston receiving a formal reprimand. Senators Glenn and McCain were cleared of having acted improperly, but were criticized for having exercised “poor judgment”.
On May 1, 1987, San Francisco thrift regulators completed a 285-page report on Lincoln Savings. They considered Lincoln Savings to be the biggest scandal of all time. They recommended that Lincoln be seized by the government due to its unsound lending practices. In 1989, Lincoln Savings collapsed, at a cost of $3.4 billion to the federal government, which had to make good on deposit guarantees. Some 23,000 Lincoln bondholders were defrauded and many investors lost their life savings. The total bondholder loss came to between $250 million and $288 million. The federal government was eventually liable for $3.4 billion to cover Lincoln’s losses when it seized the institution.
The Federal Government filed a 168-page Racketeering Influenced and Corrupt Organization (RICO) complaint seeking the return of $1.25 billion from American Continental Corporation. The RICO action charged that American Continental had stolen $1.1 billion dollars of federally insured funds from Lincoln Savings through several fraudulent investments. Keating was convicted of conspiracy, racketeering, and fraud, and served time in prison before his conviction was overturned on appeal in 1996. In 1999, he pleaded guilty to lesser charges and was sentenced to time served.
By the late 1980s, Congress decided to address the thrift industry’s problems. In 1989, it passed the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) that instituted a number of reforms of the industry. The main S & L regulator (the Federal Home Loan Bank Board) was abolished, as was the bankrupt FSLIC. In their place, Congress created the Office of Thrift Supervision (OTS) and placed Thrifts’ insurance under the FDIC. In addition, the Resolution Trust Corporation (RTC) was established and funded to resolve the remaining troubled S & Ls. The RTC closed 747 S & Ls with assets of over $407 billion. The Thrift crisis came to its end when the RTC was eventually closed on December 31, 1995. The ultimate cost to taxpayers was estimated to be as high as $124 billion.
“Barbarians at the Gate – The Fall of RJR Nabisco.”
The RJR Nabisco deal was the largest takeover and subsequent restructuring (i.e., the selling off of Nabisco’s component parts) in American history. The story of this deal, which took place in the Fall of 1988, is told in one of the most highly acclaimed pieces of business investigative journalism – “perhaps the best business narrative ever written…”- by Bryan Burrough and John Helyar, Barbarians at the Gate – The Fall of RJR Nabisco. It is the true story of a 1980’s style LBO – an unprecedentedly detailed look at how financial operations at the highest levels were conducted. It is also a social history of wealth at the twilight of the Reagan era – a true story of the “Masters of the Universe” (an actual derogatory term used to describe corporate raiders) going to war against each other for a prize – money and prestige. Much of this discussion comes from Burrough’s and Helyar’s book.
In its prime, RJR Nabisco was once America’s nineteenth largest industrial company. The tobacco and food conglomerate owned hallmark brands such as RJ Reynolds cigarettes, Oreos, Ritz Crackers, Del Monte Foods and even a small stake of ESPN. Due to a market crash in 1987 and growing liability from pending tobacco lawsuits, RJR Nabisco’s stock was depressed. Over time, the continually low stock price left the company grossly undervalued and vulnerable to takeovers. Displeased with the market’s perceived discount, management undertook several initiatives to yield the company its rightful valuation; all of which were unsuccessful. After exercising virtually all alternatives, The CEO of RJR Nabisco, F. Ross Johnson, finally resorted to taking the company private through a management (as compared to an outside, third-party) buyout of the firm.
The transaction became complicated when a bidding war developed between the management led offeror and outside third-party offerors. Such a situation is called a hostile takeover. Shearson Lehman led the management team’s efforts, while Kohlberg Kravits and Roberts (KKR) led the primary outsider activities. KKR assembled a team of experts from other Wall Street Banks, Drexel Burnham, Merrill Lynch, Morgan Stanley, and Wasserstein Perella & Co., to help it beat back the Shearson/Management led group.
Management’s initial bid was $75/share, which was very low, so low that it invited competing bids. KKR offered $90/share, a figure that Management could not beat. So, Management brought in a team from Salomon Brothers led by John Gutfreund and Tom Strauss that had $3 billion in capital. The Management group (Shearson, Salomon and RJR) countered with a bid of $92. As bidding jacked the price up, more and more debt was to be assumed by RJR Nabisco. (The KKR bid went to $94 with Management going to $100. First Boston entered the bidding with a proposal that could go from $105 -$118. KKR countered at $106. Management went to $112; KKR stood at $109.
It was up to the RJR Nabisco board of directors to select the winner of the bidding war. Which proposal was in the best interest of the company and its shareholders at large? The Board formed a Special Committee to analyze the offers. It was faced with a tough decision: acquiesce to the iron grip of the KKR team or hand victory to the Management team. The Special Committee chose KKR.
KKR won, at a price of $109 a share. With a winning bid of $109 a share, the aggregate deal value would be close to $31.1 billion, up significantly from the management group’s first proposal of $17.6 billion. It was the largest merger in history, a record that would stand for nearly a decade. RJR Nabisco shareholders received a premium of $12 billion. Johnson netted over $60 million and put millions more into the hands of executives, lawyers, and bankers involved in the deal.
RJR Nabisco walked away as the ultimate loser. Under a mountain of debt, the company’s decline accelerated. All available cash was used to pay off its junk bonds, while its rivals were able to reinvest all profits back into their businesses. The result was a wounded company that took 10 years to get over its LBO debt.
The Bonfire of the Vanities
A fictional look of “the zeitgeist of the 1980’s in all its money-lusting glory” was Tom Wolfe’s The Bonfire of the Vanities, published in October 1987. It has been called the quintessential novel of the 1980s, a story that“…captured the essential chaotic spirit of American life in the eighties through a description of the raw anxiety that separated America’s arrogant haves and resentful have-nots.” (Century, p. 487) Wolfe meant to capture the essence of Wall Street and those “masters of the universe” that ran the American financial industry. Wolfe famously claimed that writing and reading about the super-rich was the 1980s’ version of pornography.
The Bonfire of the Vanities is the story of Wall Street bond trader Sherman McCoy, who was “going broke on a million dollars a year!” The story is a drama about ambition, racism, social class, politics, and greed in 1980s New York City, and centers on three main characters: WASP bond trader Sherman McCoy, Jewish assistant district attorney Larry Kramer, and British expatriate journalist Peter Fallow.
The book contrasts the extremes of opulence and squalor, the former symbolized by McCoy and his Park Avenue-Wall Street set, the latter by the Bronx County Criminal Court with its crummy and overcrowded facilities, its clientele of black and Hispanic criminals, and its harried, underpaid, precariously middle-class judicial and law enforcement personnel. Wall Street has come back from the down times of the ’70s. People are making big money. There is tremendous wealth, but then there’s this other group of people out there and they’re mostly black, Hispanic, and working-class people who are resentful, envious, and angry about what’s going on Wall Street.
Sherman McCoy, a thirty-eight-year-old, arrogant, egotistical Yale-educated bond trader on Wall Street considers himself a “Master of the Universe.”- the best at doing bond deals. He lives in the “right” neighborhood, in a tenth-floor duplex on Park Avenue. He has a perfect wife and child, as well as a Mercedes and a mistress. But McCoy must deal with the fallout of a hit-and-run car accident that results in the death of Henry Lamb.
McCoy and his mistress miss a turn off a New York City freeway and get lost in a “bad” section of the South Bronx at night. They are approached by some black youth, and they immediately think they are in danger. In an effort to get away from the threatening situation, with the mistress driving McCoy’s car, they hit Henry Lamb, seriously injuring him. Henry is negligently treated in the hospital and ultimately dies from the consequences of the malpractice.
This sets the scene for legal troubles that ruin McCoy, professionally and personally. A hack reporter for the local city tabloid newspaper picks up the story and writes a series of inflammatory articles about it, which stirs up the neighborhood, resulting in protests. The McCoy case becomes a huge cause celebre in The City, exploited by an influential black minister, who stirs up the Black Community for ulterior purposes. The notoriety causes the city prosecutor to initiate an investigation, which focuses on McCoy. McCoy is cynically dragged through the legal system and becomes a nervous wreck incapable of closing his bond deals, proving that he is not the master of the universe. McCoy’s criminal trial ends in a hung jury (the jury being split along racial lines); McCoy is found liable to Lamb in a civil trial where the jury awards 12 million dollars, thereby financially ruining McCoy. McCoy finally loses his $1 million a year job; and, of course, his $3.2 million dollar apartment that was featured in Architectural Digest, his Mercedes, his mistress, his daughter, and his wife.
Another book that described Wall Street of the 1980s was Den of Thieves by James B. Stewart. According to one reviewer, any discussion of Wall Street criminality in the 1980s must begin with James Stewart’s Den of Thieves. According to Stewart, Wall Street desperados Martin Siegel, Dennis Levine, Ivan Boesky, and Michael Milken were participants in what Stewart considers “the greatest criminal conspiracy the financial world has ever known.”
Hollywood provided its own depiction of 1980s’ “greed cult” in the movie Wall Street (1987). In Wall Street, Michael Douglas, played the loathsome and crooked stockbroker Gordon Gekko, who famously blurted out the line that “greed is good”. The character of Gordon Gekko was based on Ivan Boesky, especially regarding a famous speech he delivered in May 1986 on the positive aspects of greed during a commencement ceremony at the Haas School of Business of UC Berkeley, where he said in part “Greed is not a bad thing…. I think greed is healthy. You can be greedy and still feel good about yourself.”