Junk Bonds: A Drexel Burnham Lambert Legacy

By: EW News Desk Team   Date: 14 June 2011

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EW News Desk Team

Always on the look out for the latest news to monitor the state of the world economy.

EconomyWatch, News Desk Team

 

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14 June 2011

Ares is an investment firm which has $37 billion of funds invested in private equity, high-yield bonds and other corporate debt. Canyon Partners, an alternative-investment firm that manages $18 billion. Imperial Capital, is a boutique investment bank.

So what do these investment firms have in common?

All three firms can trace their origins to Drexel Burnham Lambert, an investment bank that collapsed into bankruptcy in 1990, fatally wounded by an insider-trading scandal.

In a story by The Economist:

Michael Milken, Drexel’s most talented and best-paid financier,was sentenced to ten years in prison after pleading guilty to six counts of securities fraud. His sentence was later commuted and he was released after serving 22 months.

He was also forced to pay much of the huge bonuses he earned at Drexel in fines and settlements.

For much of the 1980s Drexel was the hottest firm in investment banking, thanks to its dominance of the market for high-yield corporate bonds, or junk bonds, of which Mr Milken was king.  Drexel used its muscle in high-yield bond trading, which Mr Milken had built up in the 1970s, to push into other areas of investment banking such as mergers and acquisitions and underwriting.

By 1986 Drexel, which in its long history had not previously threatened to join the financial elite, was Wall Street’s most profitable firm.

But Drexel slumped under the weight of legal battles and the $650m fine it agreed on with the American government to settle an investigation of alleged securities fraud. When Mr Milken was forced out at the end of 1988, the firm lost its biggest source of revenue.

However Drexel has left three enduring legacies:

  • a junk-bond market that has grown at least sevenfold since the firm’s demise;
  • the firms and industries, from gambling to cable television, that owed their rapid expansion to the investment bank’s junk bonds;
  • and the influence of the “Drexel diaspora”, the young MBA graduates who worked in the 1980s under Mr Milken, on the finance industry in Los Angeles and elsewhere.

In 1990 the outstanding stock of junk bonds  was about $150 billion. Now the total is over $1 trillion. 

Like all other credit, the junk-bond market was badly damaged during the recession. But it has bounced back, just as it did in the early 1990s and early 2000s. This year new issuance has surged: with around $200 billion raised in America already, the total for 2010 is sure to be a record.


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