TIME: Almanac 1993/TIME Almanac 1993.iso/time/022690/0226208.000

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COVER STORY

Predator's Fall


The collapse of Drexel Burnham marks the end of a money-mad era
of hostile takeovers, lavish living and heedless disregard for
debt

By JOHN GREENWALD -- Reported by Mary Cronin and Thomas
McCarroll/ New York and William McWhirter/Chicago


    "Are the vultures still out there?"

    -- Drexel staffer, sneering at reporters as she walked out
the door

    "Vultures? Look who's talking."

    -- Security guard


    The final plunge of the most powerful and dreaded firm on
Wall Street in the Roaring Eighties came with astonishing speed.
Like the abrupt fall of the Berlin Wall thousands of miles away,
the collapse suddenly confirmed what everyone in the financial
world could already feel in the wind: a new era had arrived.
After a desperate three-day search for cash in which it was
spurned by its bankers, Drexel Burnham Lambert Group filed
bankruptcy papers an hour before midnight last Tuesday.

    While only the parent company sought protection under
Chapter 11, no one expected the investment firm to rise from the
ashes. In an industry that operates on trust and good faith,
Drexel had exhausted its reserves. The move meant that Drexel,
whose financial wizardry reshaped corporate America and ushered
in an age of runaway debt and excess, will swiftly liquidate its
business. The 152-year-old titan -- with 5,300 employees and
$3.6 billion in assets -- will vanish almost overnight in the
biggest failure in Wall Street history.

    Drexel's staff got the word in a terse statement from chief
executive Frederick Joseph over the firm's intercom. Joseph
refused to take questions and quickly signed off, leaving
stunned employees to hunt for scarce jobs in an already
depressed Wall Street market. Drexel's layoffs, which began
Friday, will add thousands more workers to the 37,000 already
dismissed by investment firms in the past two years, almost 10%
of Wall Street's work force. In a final bitter send-off, the
firm's employees, who owned 54% of Drexel's stock, saw the
value of their holdings evaporate with the bankruptcy filing.

    In the firm's lobby at 60 Broad Street in New York City,
security guards searched bags to prevent workers from carting
away computers and company records. "People are in a state of
shock. They're laughing and crying," said bond salesman Taylor
Greene. Retorted a young broker as he stepped into a limousine
with one last show of '80s bravado: "I'll enjoy reading about
all this from Hawaii."

    The echo carried that far and beyond. Drexel's notorious
junk bonds -- debt instruments that pay high rates of interest
because of the relative shakiness of the ventures they fund --
turned the financial world topsy-turvy and helped set the tone
for the money lust that gripped America in the '80s. Armed with
the bonds, corporate raiders swiftly raised the money they
needed to attack even the largest companies. At the same time,
investment bankers raked in billions of dollars by advising the
raiders and selling junk bonds to eager borrowers. In what
corporate America saw as a glorified protection racket, Drexel
and its imitators sold services to targets as well, to help
them keep raiders at bay.

    On Wall Street the debt-propelled takeover binge gave rise
to the era's get-rich-quick mentality. Michael Milken, the
deposed Drexel guru who pioneered junk bonds and nurtured them
into a $200 billion market, was paid $550 million in 1987 for
his unrivaled expertise. In a perverse version of the
trickle-down theory, lower-echelon bankers raked in
multimillion-dollar salaries, and new recruits with two years'
experience earned six-figure sums. The fantastic payoff created a
brain drain as the best and the brightest from top colleges and
business schools across the U.S. flocked to Wall Street. In
1986 nearly half the senior class at Yale applied for jobs at
First Boston, a leading Wall Street investment banker.

    Thanks in part to Drexel, the 1980s became the decade of the
deal. In 1986 alone, 3,973 takeovers, mergers and buyouts were
completed in the U.S., at a record total cost of $236 billion.
While some takeovers shook up overly complacent managers and led
to useful restructuring, much of the raiding served only to
distract corporate America from its real work of improving
products and services. In the view of Wall Street's critics,
hundreds of deals were done for the sake of the fees and stock
payoffs they would generate. This was not the way Wall Street
traditionally operated, but in that hotly competitive
environment many firms followed Drexel's lead. The resulting
riches created a whole new spending culture as Wall Streeters
found new ways to dispose of their wealth, buying
multimillion-dollar Manhattan apartments, building lavish
estates in Connecticut and on Long Island, commuting to work in
limos, seaplanes and helicopters.

    But now Wall Street's merger machine has run out of gas,
largely because corporate America has loaded up with all the
debt it cares -- or dares -- to take on. Wall Street is
suffering a dearth of deals, but no one is shedding tears for
it. The flashy wealth displayed by investment firms has created
a backlash on Main Street, which watched with mounting fury as
Wall Street got rich through paper-shuffling deals that
manipulated companies at the expense of workers and
communities. "There's a lot of pent-up anger and disgust with
behavior on Wall Street," says Samuel Hayes, an
investment-banking professor at the Harvard Business School.

    In a TIME/CNN poll taken last week by the firm Yankelovich
Clancy Shulman, 63% said Wall Street bankers and brokers could
be trusted "somewhat" or "a little" to do what is best for the
U.S. economy while 30% said "not at all." Regarding mergers and
takeovers, 68% viewed them as "not a good thing" for the U.S.
economy and 56% saw the need for more government restrictions
on such deals. The corporate debt piled up in the 1980s will be
a problem in the next decade, according to 74%, who saw it as
"serious" or "very serious."

    Drexel's demise was greeted with little sympathy, even on
Wall Street. Many experts regard the firm's fall, caused largely
by the collapse of its $1 billion junk-bond portfolio, as a just
comeuppance and a sign that Wall Street is entering a period of
welcome sobriety. Drexel, after all, was more than just a tough
competitor; it was viewed as a bad influence. Last year the
company agreed to pay a $650 million fine and pleaded guilty to
six counts of mail and securities fraud. As part of the
settlement, federal prosecutors required Drexel to dump Milken,
who now faces a 98-count fraud and racketeering indictment. "The
era of extravagance and insanity has come to an end," says
economist Pierre Rinfret, who runs a Wall Street consulting
firm. "This is a breath of fresh air. Drexel got what it
deserved. These guys could destroy the country. There is no
rhyme or reason for what has been going on."

    As its legacy, Drexel leaves behind a battered junk-bond
market and hundreds of corporations staggering under debt. Last
week the prices of junk bonds, some of which had lost as much
as half their face value in recent months, rebounded as
investment firms bought them up to reassure the marketplace
about their stability. But in the long run, the overleveraging
of America could spell trouble if the country plunges into a
recession and profits tumble, leaving companies unable to meet
their interest payments.

    Junk bonds were a little-known security when Milken opened
Drexel's Beverly Hills office in 1978. Seated at an X-shaped
trading desk, Milken first peddled junk for small and
medium-size companies whose weak credit ratings kept them from
issuing bonds that paid lower interest rates. When investors
snapped up the junk, Milken expanded the market for his new
securities. The tireless promoter argued that the risk of a
junk-bond default was scarcely greater than the risk for
blue-chip corporate bonds. Since junk securities paid interest
rates about six percentage points higher than conventional
bonds, Milken found many high rollers willing to buy them.

    By the mid-1980s junk had become so popular -- and Milken
so powerful -- that corporate raiders could launch a bid backed
by little more than one of Milken's trademark letters stating
that he was "highly confident" of lining up the necessary
financing. Just for the ominous letters, Milken charged fees as
high as $3.5 million. Backed by Milken, Texas oilman T. Boone
Pickens attacked Gulf Oil in 1984, forcing the energy giant to
merge with Chevron and earning nearly $400 million from his
seven-month raid. Later Milken bankrolled Carl Icahn in a $1.2
billion takeover of TWA. Supported by Drexel's bonds, the
little-known firm Kohlberg Kravis Roberts became America's
buyout king, acquiring 35 companies for more than $60 billion
since 1976.

    Junk bonds proved to be the ideal weapon for exploiting a
weakness in corporate America that raiders were quick to detect.
They saw that the stock market valued many large companies at
prices well below what their assets would fetch if the companies
were bought and broken up. By using junk bonds to build their
war chests, takeover artists could pay a premium to shareholders
and still hope to make a profit by dismantling a target company.

    Lured by the seemingly inexhaustible demand for junk-bond
financing, Drexel's Wall Street rivals rushed into the
profitable business. The newcomers included such prominent firms
as Goldman Sachs, First Boston, Merrill Lynch and Shearson
Lehman Hutton. While Drexel's grip on the market gradually
slipped, in 1985 it controlled more than half of the new issues.
"Drexel is like a god," Michael Boylan, president of the
publishing firm Macfadden Holdings, declared in a magazine
article that a Drexel executive proudly framed. "They are
awesome. You hate to do business against them."

    For all its power, Drexel had few friends among its
colleagues. Even in an industry of flinty-eyed dealmakers,
Drexel's way of doing business struck many people as arrogant
and smug. "Dealing with them was repugnant," says an executive
of Prudential-Bache Securities. "They had this self-ordained
attitude of importance. They broke from all the established
rules within the underwriting community."

    Drexel's most egregious technique was to force companies
into unwanted deals, executives say. In one battle that wound
up in court, Staley Continental, a food producer based in
suburban Chicago, accused Drexel of trying to pressure Staley
executives into launching a buyout bid for their company. Before
Staley's $220 million suit reached an out-of-court settlement
in 1988, the sensational charges were the talk of Wall Street.
"They appealed to your greed," says Robert Hoffman, who was
Staley's chief financial officer at the time. "And if that
didn't work, they appealed to your fear that someone else might
take over your company and throw you out."

    As Milken's clout grew, financial journalists described him
as the most powerful financier since J.P. Morgan. But Milken's
penchant for working by his own rules and controlling every
situation proved to be his downfall. Drexel's huge profits and
free-wheeling methods attracted the attention of federal
prosecutors who believed that, among other offenses, Milken fed
inside information to a network of traders to manipulate the
stocks of his target companies. Prosecutors first snared Dennis
Levine, a Drexel investment banker, who pleaded guilty in 1986
to four counts of profiting from insider trading. The Government
then got Levine to implicate Ivan Boesky, a Wall Street
speculator, who was fined $100 million for insider trading. He
in turn agreed to help prosecutors pursue Milken, who had become
the ultimate Mr. Big. (Boesky, bearded and gaunt, now resides
in a Brooklyn halfway house, where he is completing a three-year
prison sentence.)

    Armed with Boesky's testimony, prosecutors threatened to
bring racketeering charges against Drexel, which would have
permitted the Government to tie up more than $2 billion of the
firm's capital. Forced to the wall, Drexel agreed to pay the
$650 million and give up Milken, who was indicted last March.
He was originally scheduled to come to trial next month, but the
Government is considering broad new charges that could delay the
case.

    While the huge fine sapped Drexel's strength, the killing
stroke was the severe slump in the $200 billion junk-bond
market. Several factors -- a rising default rate, a slowing
economy and a new federal law requiring S&Ls to dispose of their
junk bonds -- conspired to send the prices of such securities
plunging to 50% or less of their face value since last fall.
Stuck with more than $1 billion in devaluing junk, Drexel's
credit rating began sliding, and its banks cut off credit two
weeks ago. The parent company, starved for cash, began to siphon
money from the investment firm's coffers until Government
regulators halted that maneuver. After a frantic search for a
bank bailout or a merger partner, directors of Drexel Burnham
Lambert Group agreed to put the company into bankruptcy
proceedings.

    Drexel executives hurriedly moved to sell off the firm's
assets, in many cases at fire-sale prices. Drexel attempted to
offer whole departments for sale, including Milken's old
junk-bond operation in Beverly Hills, but rival firms turned up
their noses at anything that might carry legal liabilities or
the taint of scandal. The firm's stockholders will get little
or nothing, most notably Belgium's Lambert Group, which owned
26% of the firm and may have to take a $92 million write-off.
Creditors include Taiyo Mutual Life, a Tokyo firm with a $70
million claim, and Milken himself, who says he is owed more than
$200 million in compensation.

    In Washington the Government's top economic team stood by
with folded arms and watched the company fail. While Federal
Reserve Board Chairman Alan Greenspan and Treasury Secretary
Nicholas Brady carefully monitored the situation, the team
decided that U.S. financial markets could weather the collapse,
in part because junk bonds were already trading near all-time
lows. Said an embittered Drexel executive: "What we needed was
a pittance, and the Government decided just to let the company
go. With a little nudge from the Government, the banks would
have put a package together."

    Drexel's outcast employees have company in their misery. The
firm's crack-up comes amid a flurry of reversals for the
highflyers who symbolized the boom time. Last month Peter Cohen
stepped down as chairman of Shearson Lehman Hutton, the firm he
had built into a Wall Street giant that ranked second only to
Merrill Lynch. Like so much that flourished during the hothouse
decade, Shearson simply grew too fast. Beset by falling
revenues, failing deals and internal disputes, Cohen was forced
out by James Robinson III, the chairman of American Express,
Shearson's parent company.

    The pitfalls of overreaching were on full view last month
when the U.S. retailing empire that Toronto developer Robert
Campeau assembled in the '80s was placed under the protection
of federal bankruptcy court. A hard-driving raider, Campeau had
used junk bonds to help finance the $10.2 billion he paid for
Allied Stores and Federated Department Stores, whose ten chains
include Bloomingdale's, Stern's and Jordan Marsh.

    Now investors are watching carefully for signs of weakness
in the ultimate deal: the 1988 buyout of RJR Nabisco, which
Kohlberg Kravis Roberts, headed by Henry Kravis, acquired for
$25 billion. The battle for RJR combined all the excesses of the
era, pitting Milken and Kravis against Cohen and F. Ross
Johnson, the RJR chairman who stood to make more than $100
million by winning the fight. The victorious Kravis walked off
with $75 million in fees alone as part of his prize.

    While titans tangled for the last of the megadeals, the
ranks of their troops were shrinking drastically in the last
years of the '80s. Merrill Lynch, which lost $213 million in
1989, last month announced plans to let 3,000 of its 41,000
employees go by the end of this year. The bleak job outlook
deters business-school students who a few years ago might have
eagerly aspired to investment-banking jobs. "A lot of people are
shying away from Wall Street because the jobs are not there,"
says Mike Russell, 25, editor of the Harvard Business School
newspaper. "There is an air of uncertainty about the Street.
People aren't convinced of the financial returns and are worried
about job security."

    The new hot-job category for many students is "turnaround
consulting," which develops the skills to rescue troubled
companies -- including overleveraged firms that have been
through the takeover wars. The new heroes are turnaround
specialists like Sanford Sigoloff. Long known as Ming the
Merciless for his fierce cost cutting, Sigoloff now runs the
bankrupt U.S. operations of Australia-based Hooker Corp., which
loaded up on debt to acquire the B. Altman and Bonwit Teller
department-store chains.

    Not to be outdone, Wall Street's investment bankers are
lining up for their share of the money to be made from the
wreckage of the '80s. Observes Robert Reich, professor of
political economy and management at Harvard's Kennedy School of
Government: "Much of the impetus behind the leveraged buyouts
was to bust up companies that were frantically put together in
the '70s. Many times it was the same investment bankers and
lawyers who then proceeded to take them apart in the '80s. In
the '90s these same teams will work on reducing debt loads to
strengthen core businesses."

    The takeover fevers that racked the '80s have already begun
to abate. The total number of U.S. mergers and acquisitions
plunged 14% last year, to 3,412 deals, and is now declining at
a brisker rate. Only 165 transactions were completed last month,
down 56% from January 1989. "The big-fee merger and acquisition
game is pretty much over," says Donald Ratajczak, director of
the Economic Forecasting Center at Georgia State University.
"There are still going to be deals, but nothing like we saw in
the '80s."

    A prime reason is the severely depressed state of the
junk-bond market, where shell-shocked investors are wary of
buying new issues. Of nearly $300 million in bonds that were
scheduled to be sold this month, virtually every offering has
been canceled or postponed. Without the ability to tap the junk
market, would-be raiders will no longer be able to take aim at
substantial targets.

    For corporate executives, that prospect should bring a
feeling of relief. While raiders argue that takeovers have made
corporate America more productive and efficient, managers call
the threat of attack a nerve-racking and costly distraction that
inhibits their ability to focus on long-term growth. Each
argument has its merits, but after a decade of relentless
takeover bidding, debt is becoming a dirty word and raiders have
lost their prestige.

    In the 1990s corporations will continue to be bought and
sold. But the deals will reflect old-fashioned values, like the
strategic compatibility of companies with one another, rather
than the profits to be made from doing a deal. "The whole system
got out of whack," says Myron Lieberman, a senior partner of the
Chicago firm Altheimer & Gray, which has specialized in buyouts
for 25 years. "We just threw out considerations of how we were
going to make the new companies healthy."

    For Roderick Hills, a Drexel director and former chairman
of the Securities and Exchange Commission, the deepest threat
posed by the investment firm's collapse may be the fervor for
regulation it inspires. As Hills told TIME correspondent Richard
Behar, "The inevitable result of a significant financial failure
is that somebody thinks they can pass a law to stop another one.
And it's just as inevitable that the law they pass does more
harm than good. I doubt that there are any broad legislative
lessons to be drawn from the Drexel experience, and I fear that
our Congress will try to draw them."

    While Congress has been eager to investigate debacles like
Drexel's, it has shown little interest in enacting new laws to
curb financial markets, even after the 1987 crash. The real
lesson of the fall of the most money-mad firm of a money-mad
decade is that in any free market, a heedless competitor can
lead virtually the whole industry astray. The pendulum is
swinging back now, but the impact of the debt that Drexel's junk
bonds loaded on corporate America will not vanish as swiftly as
the perpetrator.


____________________________________________________________
PREDATOR'S FALL

MICHAEL MILKEN: Junk-Bond King

    Drexel's wizard financed many of the largest takeovers of
the 1980s. Now running a management consulting firm in Los
Angeles, Milken, 43, is preparing his defense on 98 counts of
insider trading and other crimes.

    Milken's raucous annual junk-bond bash in Beverly Hills was
dubbed the Predators' Ball. In her 1988 book on Drexel, The
Predators' Ball, author Connie Bruck reports that a close
associate of Milken's provided visiting tycoons with attractive
young female escorts. "How could I get all these guys to come,"
he reportedly said, "if I didn't have the girls?"


ROBERT CAMPEAU: Overweening Raider

    The Canadian, 66, borrowed more than $11 billion to buy the
Allied and Federated store groups, then could not pay the
interest on his debt. The retailing operations filed for
bankruptcy last month.

    Stamina is what distinguishes a man, Campeau liked to say.
Face-lifts, hair transplants and daily laps in his Olympic-size
indoor pool helped him prolong the vestiges of youth. His $5
million Toronto mansion is reminiscent of Versailles. But like
one resident of that palace, Louis XVI, Campeau has run out of
luck.


PETER COHEN: Empire Builder

    After losing a titanic battle to buy out RJR Nabisco, the
Shearson Lehman Hutton chairman suffered several setbacks in his
grand plans to make his firm No. 1 on Wall Street. In January,
Cohen, 43, was forced to resign.

    An abrasive executive, Cohen reminded rival investment
banker Theodore Forstmann of a "Mafia don," according to authors
Bryan Burrough and John Helyar in their best-selling book,
Barbarians at the Gate. Looking for legal advice in a tense RJR
meeting, Cohen shouted at Forstmann's longtime attorney, Steven
Fraidin, "Hey, you! Lawyer. I'm talkin' to you."


HENRY KRAVIS: Lion of the LBO

    His investment firm, Kohlberg Kravis Roberts, is the top
practitioner of the leveraged buyout. But junk bonds issued in
the takeover of RJR Nabisco have fallen sharply in value, and
KKR has missed or delayed payments on other debt.

    After snatching RJR from the company's chief executive, Ross
Johnson, Kravis played a peacemaking round of golf with him. But
the hypercompetitive Kravis reportedly could not resist boasting
about his score afterward. "For Christ's sake!" responded
Richard Beattie, Kravis' attorney. "You could at least let the
guy win on the golf course!"


____________________________________________________________
JUNK BOND CHRONOLOGY

    1969

    September. Michael Milken enrolls at Wharton School, where
he writes a paper contending that downgraded bonds are good
investments.

    1970

    Milken joins Drexel at a salary of $25,000.

    1977

    Spring. Lehman Bros. offers the first "junk bonds," which
are low rated from the outset. Drexel soon follows suit.

    1978

    July. Milken, already Drexel's main profit producer, moves
his operations to California.

    1983

    Drexel first promotes junk bonds to finance LBOs, signaling
the start of takeover mania.

    July. Milken launches first $1 billion junk-bond offering,
to finance MCI's expansion. Milken then backs T. Boone Pickens
in a failed bid for Gulf Oil.

    1985

    January. Carl Icahn mounts a junk-fueled raid on Philips
Petroleum. He fails but in December buys TWA with $660 million
in junk-bond financing.

    August. With Drexel's help, Ronald Perleman bids for
Revlon. The ultimate price: $900 million.

    December. Warren Buffett predicts that "one day, junk bonds
will live up to their name." Junk bonds outstanding: $59
billion. Drexel's share of new business: 70%.

    1986

    July. Unable to meet payments on its junk-bond debt, LTV
files for bankruptcy. Buyout of Safeway store chain leaves
company with a debt-to-equity ratio of 45 to 1.

    Drexel earns $545.5 million, a 79% increase over 1985,
making it the most profitable firm on Wall Street.

    1987

    Milken earns $550 million, more than four times Drexel's
total profits. If Milken were a publicly held company, he would
rank 65th in earnings, just ahead of McDonald's.

    Junk bonds outstanding: $150 billion. Rate of annual
default: 3%.

    1988

    November. Kohlberg Kravis Roberts relies on the largest
junk-bond issue in history, worth $5 billion, to help finance
its $25 billion buyout of RJR Nabisco.

    December. Drexel agrees to pay a record $650 million fine
for securities fraud and other felonies. The company posts a
$167 million loss for the year.

    1989

    March. Milken, along with his brother Lowell and a former
Drexel employee, is indicted on 98 counts of criminal
racketeering, securities fraud and other crimes.

    June. Milken resigns from Drexel.

    1990

    January. Overburdened by its $2.25 billion in junk-bond
debt, paying interest rates as high as 17.75%, Campeau Corp.
files for bankruptcy.

    February. Drexel files for bankruptcy.

    Junk bonds outstanding: $200 billion. Estimated default
rate: 10%.


_______________________________________________________________
INVESTMENT POLL

    How much do you trust Wall Street bankers and brokers to do
what is best for the economy?

    A great deal   4%
    Somewhat      30%
    A little      33%
    Not at all    30%

    If you had $1,000 to spend, do you think investing it in
the stock market would be a good idea or a bad idea?

    Good idea     26%
    Bad idea      68%

    Do you think mergers and takeovers are good for the
nation's economy?

    Yes           20%
    No            68%

    Do mergers and takeovers help or hurt the following:

                                                    Help   Hurt

    The lawyers and bankers who arrange them         80%    13%
    The top management of the companies involved     52%    36%
    Employees of the companies                       26%    62%
    American consumers                               25%    60%

  How much of a problem will heavy corporate debt be for the
economy in the 1990s?

    Very serious  25%
    Serious       49%
    Minor         17%
    No problem     3%


[From a telephone poll of 500 adult Americans for TIME/CNN on
Feb. 14 by Yankelovich Clancy Shulman. Sampling error plus or
minus 4.5%.]