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Junk Bonds: a Financial Revolution That Failed : Wall Street: The economic highfliers of the 1980s' growing economy are a peril in the downturn of the '90s.


What was going on? In part, people were giving a vote of confidence to continued economic growth. An index of consumer confidence prepared by the University of Michigan soared by more than 50% from the depths of the last recession to the boom year of 1984 and remained high through the rest of the decade.

"It was a sign of confidence and optimism in the future--and also a willingness to take risk," Solow said of the public's willingness to go into hock.

And, in part, members of the public had learned a lesson in speculation from the inflationary 1970s. In the 1970s, people who stretched their pocketbooks to buy costly houses usually came out well, because inflation raised the value of their investment while in effect cutting their debt, Krugman said. That was because their loan payments stayed constant as their incomes grew.

"In effect, the explosion of personal debt in the '80s was a delayed response to what the '70s taught people," he said.

There's a catch, however. Such debt or leverage works best when the economy is rising. Payments remain tolerable as long as income holds up. But, when profits and incomes are squeezed, the debt payments can be ruinous.

"Everybody decided to kite the game--and it doesn't work," said Berkeley's Cohen. "It only works at first."

The first real chill rippled through the junk bond market in 1986, with the emergence of an insider trading scandal that focused on speculator Ivan F. Boesky but soon led to Milken's firm, Drexel Burnham Lambert. By 1987, junk bond sales were on the decline.

That year, interest rates rose sharply and fears spread that the U.S. economy was due for a recession. Then, in October, the stock market crashed. Junk bond sales fell by $5 billion, the first annual decline for the market since 1981.

Since then, the market has plunged as a growing number of debt-saddled companies have suffered distress, including Southland Corp., owner of 7-Eleven stores, the retail empire of Campeau Corp., Western Union and Revco.

In 1989, the number of merger and acquisition deals dropped for the first time in a decade--a decline that has continued this year at a 16.6% rate over 1989, according to IDD Information Services.

Overall corporate debt, a much larger figure than junk bonds, has been growing at a much slower rate for two years, the Federal Reserve reports.

Debt financing "is a wonderful idea on the upside," said Robert Dunn Jr., an economics professor at George Washington University. "As long as we had this enormous upturn in the economy, leverage made a lot of sense. What we're seeing now is a downturn, which is going to make that leverage seem vicious."

Recently, concerns have intensified about the troubled financial system--including savings and loans that relied on junk bonds and claims by business that credit is hard to come by. Commercial real estate and construction are in trouble, layoffs are on the increase and the art of rescuing troubled companies has become one of the financial world's few growth areas.

Consumer confidence, meanwhile, has fallen to its lowest levels in several years.

It all makes for a drastically different mood from the jolly 1980s.

"Is some bankruptcy lawyer the toast of the town?" asked A. Gary Shilling, a New York economist. "Today he's in the driver's seat."

The atmosphere in executive suites is changing as well.

"I think people are going to say, 'Hey--I want a strong balance sheet,' " said Shilling, who has dubbed the 1980s "the decade of greed, glitz and growth."

Consumers also face pressure to spend cautiously, although the statistical evidence is not yet clear. If history is a guide, the plunge in consumer confidence might lead to greater savings in the coming months. More basically, the aging baby boomers will be under pressure to save more for things like their children's college educations in the coming years.

Are such shifts temporary? Maybe not: A less freewheeling attitude toward risky borrowing may be rooted in long-term causes, said MIT's Solow. "It reflects the fact that the United States is becoming just one among several modern economies and not a leader," he said.

Milken's departure parallels the shift in mood, a shift many may approve of. Yet, the 1980s were a time of robust economic expansion and job creation. While Milken's economic legacy includes a list of wounded corporations, it includes others that profited handsomely from his techniques.

For many companies, his imprisonment is not happy news. Said Krugman: "There's no reason to think that a system without Michael Milken is all that good either."

Times librarian Tom Lutgen contributed to this story.



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