Bunk About Junk
BROCKWAY, GEORGE P.
The Dismal Science BUNK ABOUT JUNK BY GEORGE P. BROCKWAY A recent editorial in the New York Times opened with these words: "Michael Milken is a convicted felon. But he is also a financial...
...There are recurring rumors that one of the banks is on the verge of bankruptcy, too...
...I know, because in the days of my youth I spent many gold-bricking hours waiting in their sample rooms to see buyers...
...That may be prudence, but foreclosing production (or consumption) does not make for prosperity...
...This assumes a company with upwards of $ 15 million or $20 million in annual sales...
...The usury affects real estate developers (another impressive job description) and contractors as well as potential buyers, and commercial construction as well as residential...
...Junk bonds are just one of the forms speculation takes...
...The interest rates are usurious...
...Not surprisingly, the Federal Reserve Board (which is responsible for the availability of credit) doesn't see a problem here, anyhow...
...Milken's criminality...
...The junk bond market being thin and precarious, a $3 million issue is about the smallest anyone will undertake...
...There are certainly examples on the other side, Allied and Federated department stores being first among them...
...Escalation of rates discourages production and encourages speculation...
...Amedical researcher would scorn that diagnosis as anecdotal...
...He's been on both sides of the question already...
...A new small business has always had a tough time and always will, for the reason suggested by John Maynard Keynes...
...They were also successful...
...The Board has just reported: "There is little evidence that a 'credit crunch' is developing...
...the banks are in fact doing the job indirectly by making all those bridge loans...
...They have certainly told us enough times...
...It is not the sort of stuf f that made Milken notorious, but it is considerably more than can be expected from most newer small businesses...
...High interest becomes a selffulfilling prophecy...
...Indeed, in a sort of Malthusian progression, risk increases geometrically while rates increase arithmetically...
...It doesn't mean much to say a "majority" of businesses have no trouble with credit...
...But as John Kenneth Galbraith argued years ago in The Affluent Society, an economy that makes life unpleasant for people is something we don't need...
...That, naturally, increases the risk of failure...
...They were stuck with nonperforming loans, and Campeau's stores took refuge in bankruptcy...
...Abstractly there is no end to the escalation of interest rates, for there is no end to the escalationofrisk...
...High interest rates are amain factor of high real estate prices—and of high furniture and food and clothing prices, too...
...After the bonds were sold, the banks would be paid off, handsomely...
...But let that pass...
...For my part, I'm ready to grant that Milken is (or was) a crackerjack salesman and a mighty cute operator...
...But he is also a financial genius who transformed high-risk bonds—junk bonds—into a lifeline of credit for hundreds of emerging companies...
...If this tale isn't false, I wish somebody would cite a few shining examples...
...There is no condoning Mr...
...Actually, of course, theescalation does have an end, because potential borrowers are driven off...
...This reminded me of a story about Henry J. Raymond, the Times' founding editor and a member of Congress...
...Junk bonds are a slight variation on a very old theme, played at least as early as the Mississippi Bubble and the South Sea Bubble, both of which burst in 1720...
...They're not successful now...
...He counted on selling junk bonds, and he knew that would take a little while, especially since it was important to wait for the moment when the market was right...
...we are unable, in this supposedly family-oriented society, to provide enough affordable housing for young couples, employed and upwardly mobile though both partners may be...
...Why did the Board members do it...
...Nor, I daresay, is this the first time the Times itself has made such a discovery...
...You can see that from the fact that the Consumer Price Index, which stood at 24.1 in 1950, reached 126.1 by last December—anincreaseof 523 per cent in the 40 years in question...
...When Robert Campeau made his deals to buy the Allied and Federated department store chains, he did not put up much cash...
...Well, one thing they did was make Milken's junk-bond business possible...
...If the virtue of junk bonds is that they are a sort of handicap inspiring efficiency, why not try a different handicap by giving all the working stiffs a raise...
...Noprosperity lastslongif real estate does not prosper...
...They were carefully fine-tuned by the Federal Reserve Board...
...Whatever the situation, we can be sure that the "newer small businesses" turned away by the commercial banks are also unable to find an investment banker ready to float junkbonds for them...
...Why do the loans go bad...
...They' ve been fighting inflation...
...Having paid casual attention to some banks' advertising campaigns, I was under the impression that nothing was more likely to make a banker's day than an opportunity to lend a helping hand to a bright but inexperienced young woman with a new idea for a flower shop, or to a similarly energetic young man eager to play a part in the great drama of American business...
...Snubbed by the banks, these businesses would otherwise have shriveled...
...The Times thinks that junk bonds are good because they force companies to become more efficient (and hence more "competitive") in order to pay off the high interest charges...
...Real estate, though, is a key industry...
...The banks are essential players in the junk-bond game...
...These great leaps forward, culminating in today's 20 per cent, didn't just happen...
...Where credit tightening by banks and thrift institutions has been noted, however, it has mainly affected newer small businesses and the real estate industry...
...Raymond's successors seem to be straining to be on both sides of the junk-bond question...
...The trouble was, it turned out that the junk couldn't be sold, at least not at the necessary price...
...Old Thad Stevens (one of my heroes) asked, "Why doesn't the gentleman pair with himself...
...to sell carloads of not-of-investment-grade securities (see "Junk Bonds and Watered Stock," NL, March 24,1986...
...But a financial genius he was not...
...They protect themselves by charging even higher interest...
...Real estate loans go bad for the same reason junk bonds go bad...
...Interest charges paid by the nonfinancial sectors of the economy are now in excess of 20 per cent annually...
...If human nature felt no temptation to take a chance," he wrote, "no satisfaction (profit apart) in constructing a railway, a mine, or a farm, there might not be much investment merely as a result of cold calculation...
...49 per cent could be having a lot of trouble...
...Instead, they supplied bridge loans...
...Why wouldn't meeting a bigger payroll be a better test than paying higher interest...
...It used to be said that management's first test was meeting the payroll...
...The probability is a risk the lenders must protect themselves from...
...Unfortunately, the fight has not been remarkably successful...
...Thereis anotherissuehere...
...Not only do we have uncounted millions of homeless and ill housed...
...Junk bonds are the creation of the nation and of the Federal Reserve Board (which is, absurdly, an independent power), not of the genius of a supersalesperson...
...the food, clothing, shelter, transportation, education, medicine and entertainment I buy have all increased much more than that...
...Deregulation, combined with tightened credit, results in escalation of rates...
...Certainly he was not the first investment banker (what an impressive-sounding job description...
...As I've remarked before, this figure seems to me too low...
...They were no big buyers of junk bonds themselves (although the savings and loans snapped up about a tenth of those issued...
...Junk bonds aren't doing a job the banks are falling down on...
...Still, as everyone knows, real estate loans are prominent among the troubles of savings and loans and of commercial banks like the one pushed to the brink by the Campeau fiasco...
...Furthermore, the usual test of efficiency is a fat bottom line, and the quickest way to fatten the bottom line is to fire some people and put a leash on the rest...
...Not because the housing is not wanted or not needed, and only partly because prices are too high...
...They were only 4.9 per cent of the GNP in 1950, rising to 7.2 per cent in 1960, to 10.1 per cent in 1970, and to 15.0per cent in 1980...
...It is the high carrying charges that are to blame...
...I'm also ready to grant that a lot of emerging companies have been snubbed by banks, yet I rather wonder why...
...The banks loaned him the money to bridge that gap...
...Nor is the New York Times the first journal to discover virtue in such supersalesmanship...
...If the banks weren't seizing these opportunities, what were they doing with the money they persuaded us to deposit with them...
...One day he was prowling the House floor, trying to arrange a pair on an important upcoming vote, so he could return to New York on business...
...Moreover, we have great need of it...
...Both chains were long established...
...Every new enterprise faces a high probability of failure...
...so the banks involved couldn't be paid off...
...What is prophesied is the probable failure of the borrowers...
...New Building Permits Issued is one of the "leading indicators" of the economy...
...It all comes back to the nation's monetary policy—its rates and rules and regulations...
...But if overzealous government regulators overreact by dismantling his junk-bond legacy, they will wind up crushing the most dynamic parts of the economy...
...the majority of businesses say they have not seen any change in credit terms and have had no trouble getting credit...
Vol. 73 • April 1990 • No. 7
