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Junk Bond Scam (USA)

In the 1980s, Michael Milken, the "Junk Bond King" of Drexel Burnham Lambert, revolutionized Wall Street. He fueled the era of "Corporate Raiders" and "Hostile Takeovers" using high-risk debt.

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Timeline of the 80s Excess

  • 1970s: The Idea - Milken argues that 'Fallen Angel' bonds (Junk) yield higher returns than safe bonds, compensating for the risk.
  • 1984: The Predator's Ball - Drexel hosts its annual conference. Corporate Raiders (Icahn, Perelman) gather to plot hostile takeovers using Milken's money.
  • 1986: The Boesky Day - Ivan Boesky (Arbitrageur) is arrested for insider trading. He wears a wire and implicates Milken.
  • 1989: Indictment - Rudy Giuliani (US Attorney) indicts Milken on 98 counts of racketeering and fraud.
  • 1990: Bankruptcy - Drexel Burnham Lambert files for bankruptcy. Milken pleads guilty to 6 counts.

What are Junk Bonds and How were they Abused?

  • Definition: Bonds rated below BBB. They pay high interest (Reference Rate + 4-5%) because default risk is high.
  • The Milken Innovation: Before Milken, you couldn't issue Junk Bonds easily. He created a liquid market for them. He realized he could find capital for ANYONE.

The Scam Mechanism

  1. Financing Raiders: If a Raider wanted to buy a big company (like RJR Nabisco), banks wouldn't lend the money. Milken would say "I can raise $1 Billion in 1 hour."
  2. The Network: He would call his network of insurance companies and S&Ls and force them to buy these bonds.
  3. Quid Pro Quo: He forced clients to buy each other's junk bonds to create a fake market (Ponzi-like). "You buy his bonds today, he will buy yours tomorrow."
  4. Insider Trading: Since Milken financed the takeovers, he knew exactly which stock would go up. He passed this info to Ivan Boesky.

Lessons Learned

  1. Conflict of Interest: An investment bank cannot be both the lender and the owner/trader.
  2. Market Manipulation: Creating artificial demand for bonds is a crime.
  3. RICO Act: This was the first time the RICO Act (Designed for Mafia) was used against Wall Street bankers.

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