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.