Monday, October 5, 2009

He keeps going, and going...

Michael Milken is like the Energizer Bunny of junk bonds...

Still barred from the securities industry after his 1989 plea bargain, he's arguing again in favor of high yield debt as a fantastic tool for capital allocation and wealth/job creation. I don't disagree with him on most points. It's just that his comments below about properly assessing credit risk sound ridiculous coming from a guy who (in addition to insider trading) would literally create a company financed by his bank, then have them sell high-yield debt, then ORDER them to acquire another company, and take commissions and fees from each transaction. Amazing.

Interesting points he makes in the Financial Times:

Today’s environment mirrors 1973-1977, when markets first demonstrated the ability to heal themselves. The mid-1970s recession created unprecedented problems for financial institutions. Most banks could no longer consistently meet their customers’ financing needs. But capital markets offered an alternative through debt obligations and other securities. This allowed new forms of capital structure and assured economic expansion in the 1980s and beyond with reduced involvement by banks, whose role in financing corporate growth has shrunk ever since.

Many investors have relied on another fallacy – that rating agencies accurately rate enterprises and securities across different sectors. For much of the 20th century, AA-rated railroad bonds defaulted twice as often as single-B industrials. Recent regulations provided incentives for investment in complex, AAA-rated mortgage-backed securities never close to AAA quality. Ironically, investors will lose more money on AAA credits than on any other rating category.

This illustrates the myth that investments currently in favour are safe. In two 1982 articles – “Nowhere to Go but Down” and “Nowhere to Go but Up” – I made the points that companies with few perceived problems tend to be priced for perfection; and conversely, that it is hard to bankrupt even weak companies, which nearly always rally when investors, management and labour co-operate to sustain them. Like more than 99 per cent of companies, these enterprises do not carry investment-grade ratings. But non-investment-grade companies create virtually all net new employment.

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