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In January 2007, CAA Creative Artists Agency, which manages George Clooney, Julia Roberts, Brad Pitt and other luminaries movie industry, opened its new offices on the Avenue of Stars in Century City, Los Angeles as famous actors file and directors in the marble- lined entrance strike lucrative film contracts, more serious money is made on the floor.
The 12th floor is occupied by Ares, which has 37 billion of funds invested in private equity, high-yield bonds and other corporate debt One floor is down Canyon Partners, an alternative investment company that manages the 18 billion CAA building also houses Imperial Capital, an investment bank boutique three companies can trace their origins to Drexel Burnham Lambert, an investment bank which collapsed into bankruptcy in 1990, fatally injured by insider trading scandal.
It was twenty years ago next month Michael Milken, the most talented and highest paid financial Drexel, who was based in Los Angeles, was sentenced to ten years in prison after pleading guilty to six counts of fraud in securities securities, his sentence was later commuted and he was released in 1992 after serving 22 months, he was also forced to pay a large part of the huge bonuses that he earned at Drexel fines and regulations.
It is rare even in Hollywood to find a star that rose and fell so quickly for most of the 1980s Drexel was now the hottest in the investment bank, through its dominant position in the market for bonds high-yield companies, M. Milken was king these bonds were known as junk because they were classified in the level of investment by rating agencies Drexel used its muscle in the sale of high-yield bonds, Mr. Milken was built in the 1970s to grow in other areas of investment banking such as mergers and acquisitions and underwriting Drexel in 1986, which in its long history had not already threatened to join the financial elite, was the most profitable company on Wall Street.
But Drexel collapsed under the weight of legal battles and 650m well agree with the US government to settle a fraud investigation into alleged securities When M. Milken was forced to the end of 1988, the company has lost more great source of income His sense missed especially as the junk bond market began to implode at the end of this decade the rise in interest rates, defaults on bonds that were issued too easily in the go-go years and new regulations that forced troubled savings and loan to unload their high-yield assets all conspired to bring prices down junk bond This seemed to validate claims that the junk bonds market was a Ponzi scheme perpetuated by tight control of M. Milken of it.
These allegations proved false Drexel left three a lasting legacy junk bonds market that grew at least seven times since the company's demise; businesses and industries, gambling on cable TV, which was their rapid expansion to junk investment bank's bonds; and the influence of Drexel Diaspora, young MBA graduates who worked in the 1980s under M. Milken, the finance industry in Los Angeles and elsewhere.
In 1990, outstanding junk bonds estimated by subtracting redemptions new emissions since 1970 was about 150 billion Now the total is more than 1 trillion About two-fifths of all bonds outstanding companies in America are rated as speculative, or below investment grade BB or less, according to Dealogic, a financial data company better class bonds are not as they once were pukka much of the non-junk issued since 1992 was recorded BBB-, the lowest investment grade.
Like all other credit institutions, the junk bond market was severely damaged during the recession, but he bounced back, as it did in the early 1990s and early 2000s This year, a new issue has jump with nearly 200 billion raised in America already, the 2010 total is sure to be a record see chart 1 the recovery is in part driven by a renewed search for yield by investors disappointed by the low yields on cash or Treasuries of the interest premium they demand to hold junk tumbled see table 2.
The reopening of the junk bonds market has also allowed medium-sized enterprises access to credit again Companies that have tapped the market are a section of US businesses airlines, retailers and clothing manufacturers, health care providers, companies pharmaceutical, restaurant chains, oil-exploration companies and semiconductor manufacturers part of the new issuance is by firms seeking to block the long-term financing on good terms.
The rebirth market was helped by fewer defaults on high-yield bonds, the default rate on junk bonds remained above 8 to 14 months in 2009-10, according to CreditSights, a research firm that compared to 20 months in the previous two recessions.
Junk bonds, once scorned, are now mainstream Milken and Drexel have high yield from a cottage industry to one of the cornerstones of the financial industry, said Howard Marks, one of the first customers M. Milken and now chairman of Oaktree, a Los Angeles firm that manages approximately $ 75 billion in funds, mainly in high-yield bonds and related investments.
In the 1970s, the bond market was tiny She understood fallen angels, the titles of the old investment-grade companies that had fallen on hard times that have changed hands often and at great discounts to par While a student at Berkeley in the 1960s, M. Milken was upon empirical support to his intuition that a portfolio of these high-yield bonds would outperform a portfolio of investment grade, even taking into account the probability of default over high, it was found in a study by Braddock Hickman, a central banker and student of corporate finance, which showed that even during the depression there was a high rate of return on non-investment grade bonds the interest rate differential with respect to so-called safe bonds was more than enough to offset the expected losses.
When M. Milken began to exchange junk bonds at Drexel since the early 1970s, its land to its growing group of customers and followers was the same junk was a better bet than investment grade bonds, which had that one way to get off the High- yield bonds were resistant to the recession mid-1970s this was the crisis in the financial markets in 1974, when the share value has halved, some bonds may be purchased for price of their coupon remarkably little junk bonds went bad and investors have achieved high rates of return.
This paved the way for the opening of an important new market for unwanted emissions in 1977. From then be exchanged fallen angels ascending angels alongside corporate bonds whose prospects were better than their low status suggested the interest rates were volatile and businesses wanted to fix their cost of capital They were wary of relying on banks, which had cut credit lines to enterprises at the nadir of the recession to preserve capital.
In April of this year Drexel endorsed its first issue junk bonds when it raised $ 30 million for Texas International, a small oil exploration company Other questions followed this year, but other investment banks first took a larger share of this new market which lead did not last see Table 3 M. Milken preaching the Gospel high performance secured him a loyal customer base and growing, especially among insurers and savings banks, with an insatiable demand for lower quality securities, he helped clients make money if they did well, they came back for more and in time, they built their businesses on the supply of securities Drexel.
The key to their loyalty was the commitment of M. Milken buy or sell request links that Drexel had taken farm, and offered them a liquid market and an exit investments they did not want that cash attracted funds mutual in undesirable arena M. Milken's skills as principal on its roots in his knowledge of the issued bonds that allowed it to price accurately and wonderful memories of our businesses customers who helped find new buyers for junk others wanted to unload it and stuck around when other banks declined junk market during the recession of the early 1980s.
This fresh junk has become an important weapon for the raiders and leveraged-buyout LBO firms that came to prominence in the 1980s Drexel capacity quickly raise hundreds of millions of dollars of mezzanine debt so called because it ranks among the secured bank loans and risk equity in the capital structure made the threat credible redemptions and forced many large companies to thin costs and increasing returns to shareholders to stave off threat of a takeover.
Drexel is a large part of mezzanine financing in 1989 to 25 billion acquisition by Kohlberg Kravis Roberts, a firm takeover of RJR Nabisco, a cigarette conglomerate and Biscuit It was an example of courage and muscle two Drexel firm had at its peak, we sat around and said that if each of our existing customers buy the maximum amount they have never bought an issue, we could get 3 billion, said Dana Messina, once a seller high efficiency Drexel, now the chief executive of Steinway Musical Instruments Drexel comfortably raised 6 billion to finance the transaction.
Issues junk bonds also provided a new way for many small but growing businesses, which were deprived of capital by commercial banks indigestible and investment banks Sniffy, to finance the bread and butter activities has been catering to guys like Craig McCaw or Steve Wynn and John Malone or Ted Turner says Messina.
These entrepreneurs saw the potential for growth in their respective industries Mr. McCaw was head of McCaw Cellular Communications, an early entrant in the mobile phone business, which had 2 million subscribers when AT T bought in 1994 for 11 5000000000 Drexel also funded the bill McGowan of MCI, the company that successfully challenged AT fixed-line telephone monopoly T Drexel financed Nugget Casino Gold M. Wynn in Atlantic City and the Mirage in Las Vegas, filled with a fake volcano His company now has several luxury hotels in Las Vegas, a city whose rapid growth has much to finance high yielding Mr Malone Tele-Communications Inc. Became the largest cable TV firm in the world Its growth was financed by junk Drexel issued M. Turner pioneer new television 24 hours CNN, a channel powered by Rupert Murdoch junk was another media client.
None of the companies we funded were pure startups, said Ken Moelis, who worked in the team of corporate finance at Drexel in Los Angeles and began Moelis Co, an investment bank, in 2007 rather Drexel found the money for small businesses that had cash flow enough to make interest payments to grow Some industries are not well suited for the debt financing of the mobile phone company has not generated much initial cash and cable companies had large startup costs before the expired subscription revenue was overestimated fund companies a solution to raise more capital than necessary for them to make their first payments interest another trick is to use zero coupon bonds on which interest payments are deferred until the principal comes to Expiry date.
Drexel all corporate customers have been excited about the price extracted for this service Some felt that Drexel cut too good a deal for himself and for the true junk-bond investors Mr. Milken Drexel fees on unwanted issues were 3-4; less than 1 was typical for investment grade Drexel bankers often requires warrants for themselves and their customers to sweeten the deal.
Yet the lopsided price is a characteristic of two-sided markets, in which one of the side benefits if a lot of customers on the other side, for example, clubs that act as matchmakers for lonely hearts often charge fees more higher for men than for women, believing that single men are more likely to join clubs with lots of women members in the same way, Drexel was able to charge fees for enviable access to investor base rare most companies were willing to pay for a large number of transmitters, it wasn t silver cost was the cost of not having it, said Kyle Kirkland, who was one of the last MBA graduates hired by the office in Beverly Hills Drexel in the 1980s.
The desire to maintain the grip of M. Milken on high yield marketmaking may explain why bankers Drexel were loth share agreements with other investment banks If competitors issued many junk bonds, which would undermine the sense Mr. Milken of held that the obligations and make control more difficult market now glorified thwart rivals and stealing business under the nose of an elite Wall Street he considered lazy and snobbish .
The company had many enemies who welcomed its fall capacity of the company to quickly raise huge sums to LBOs struck fear in the heart of the business America Job losses have often followed undesired funded buyback because hitherto inefficient firms have been sweated for money, created a lot of political fury that many more jobs were created by small businesses Drexel financed that were lost in LBOs is often overlooked junk bonds, people junk was the sneer on Wall Street who abhorred the replica of the upstart Drexel bank that rivals would rather sell their investment grade ratings, rather than putting in the hours necessary analysis to hawk junk was hardly endearing Drexel also provided a useful scapegoat for the savings and loan crisis, because some savings banks Given buyers of junk bonds.
Yet unloved as it was, Drexel changed the face of corporate finance and Wall Street these days with companies such as Google and Apple, everyone takes for granted dynamism, said Moelis But Mike Milken began in the 1970s when capitalism was struggling in those days, there was very little innovation comes Drexel, a company with a visionary goal, and suddenly you could raise capital before 1977, when new questions junk bonds took off, said M. Marks, non-investment grade bonds were considered bad investments, at today's prices bad credit can be considered a wise investment if it is available at a price.
Drexel third legacy is the mark he left on the financial sector, especially in LA This most profitable division of Drexel was based so far from its headquarters in New York is largely down to the accident of the birth of M. Milken was born and raised in the San Fernando valley, M. Milken returned to Los Angeles in 1978 by taking 20 or so traders with him to be closer to his family since he was main source of profits for the company at the time, his teachers could hardly refuse.
M. Milken at its center, the operation Beverly Hills Drexel became a magnet for the best business school graduates in the 1980s, the end of this financial cohort is still active Many of them stayed Los Angeles after Drexel folded Almost all moved to the management side of the company's assets, although the sell-side skills they developed at Drexel are useful for bringing in money to manage or organize the external cofinancing for private-equity deals Los Angeles has over a large central bank money or large broker that remained was an innovative financial strain for the next step style local financial Drexel say they are free of the herd mentality which can take hold in New York on time and quality of life also helps companies say they have more difficulty in recruiting, but easier to remember, good people onal.
Some former Drexel found today in New York Rich Handler, a junk bond trader in the Los Angeles office of Drexel, moved with 35 or colleagues at Jefferies, a local investment bank; they took their knowledge of high yield bonds and investors with them Mr. Handler is now CEO of Jefferies, but the bank has long outgrown its roots in Los Angeles and high yield In 1990, it had 400 employees It now about 3,000, of which 200 are based in Los Angeles headquarters these days are in New York another alumnus is Leon Black, founder of Apollo, a corporate credit business to 55 billion under management Apollo based in New York, where Mr Black also spent his years Drexel.
Financial Drexel are not altruistic; But they were dealmakers in their pursuit of profit they also caused a democratization of credit companies that previously had to rely on conservative banks or costly equity had access to fixed income funds on the financial markets by investors that M . Milken and his junk- bond traders had grown This was a boon to the US economy limiting the capital to investment grade companies limit economic progress If a company can pay the rate for risk, it should get the money he requires.
Los Angeles is perhaps a strange house for a financial group with a focus on high-yield credit Hollywood business model is looking for a blockbuster that will pay for all investment turkeys bonds high efficiency is a different art, the trick is to avoid the losers; then the winners will take care of themselves.
Stars of the junkyard The Economist, stars, Drexel Beverly Hills, other investment banks.