28 Ibid., p. 303.
29 Ibid.
30 Ibid., p. 280. Milken did not invent junk bonds, as is often claimed. There were precedents: railroad and REIT (real estate investment trust) junk bonds.
31 Ibid., p. 282.
32 Ibid., p. 283.
33Ibid. p. 282. Between 1980 and 1982 the ratio of earnings before interest and taxes (EBIT) divided by debt payments was about 2.0. The ratio dropped to 0.8 in 1983.
The Decade of Greed
The explosion of finance initiated a new Youth Movement. In July 1986, a BusinessWeek cover story quoted a Harvard Business School professor who compared Mike Milken to J. P. Morgan.35 The comparison was taken to heart: the Harvard Business School class of 1985 included 65 members who were prosecuted for securities violations.36
Some of the corporate restructuring was productive, although much was driven by the call to “align management incentives with shareholder value.” To boost shareholder value—the stock price—every quarter, financial channels combined with clever accounting were necessary. The balance sheet expanded, often through the allure of debt and buying back equity.
In 1985, Franco Modigliani won the Nobel Prize in economics. The Modigliani-Miller theorem holds that the value of a business does not decrease when its capital structure is geared toward debt (we are incorporating the efficient market fantasy dementia here.) Impatient CEOs applied the superficial gloss of this hypothesis to borrow in frightful quantities and boost profits.37
34 Ibid., p. 287.
35 Grant, Money of the Mind, p. 393.
36 Philip Delves Broughton, Ahead of the Curve: Two Years at Harvard Business School (New York: Penguin Press, 2008), p. 157.
37 Merton Miller, the other party to the theorem, was awarded the Nobel Prize in 1990.
Volcker’s Renomination
Paul Volcker’s term as Fed chairman ran until 1983. Alan Greenspan consistently supported Volcker, in public statements and private conversations. Some of Greenspan’s forecasts warned of dire times, but he was generally discussing the problems of the economy as a whole. He put at least as much blame on federal budget deficits as on problems caused by monetary policy—a money mishap that Greenspan inferred was caused by misdeeds prior to Volcker’s term. As a member of Time’s Board of Economists, Greenspan warned in 1981 that “towering interest rates are threatening the survival of many American financial institutions.”38 The American people blamed Paul Volcker for the high interest rates, but Alan Greenspan did not. Instead, he told Time in December of 1982, “The Fed is in a box.” He supported Volcker’s increasingly lonely policy by reminding readers that bond buyers thought a rapid expansion of the money supply could eventually reignite inflation (raising longterm bond rates).39 When the press was full of tattletale gossip on the acerbic relations between Volcker and the White House (specifically, Donald Regan), Greenspan told the Times: “It’s counterproductive and it’s unfortunate. The Fed is doing as good a job as it can do in these circumstances.”40 Regan was a tough cookie. Greenspan put the Fed and Volcker ahead of his own interests.
Greenspan’s campaign for Fed chairmanship was subtle. Paul Volcker’s four-year term as chairman expired in August 1983, but it appears that the White House could not make up its mind about a successor. Wall Street put pressure on the White House to reappoint Volcker. A survey of 702 business executives published in the Wall Street Journal on June 8 revealed that 77 percent wanted Volcker to be reappointed. In second place was Greenspan: 37 percent expressed special confidence in him.41 With such support, he was in a commanding position to succeed Volcker, should the opportunity arise.
38 Charles P. Alexander, “Will Reagan’s Plan Work?” Time, February 23, 1981.
39 Charles P. Alexander, “The Elusive Recovery,” Time, December 27, 1982.
40Jonathan Fuerbringer, “Reagan vs. Fed: The Fallout,” New York Times, January 30, 1982, p. 29.
41 William Greider, Secrets of the Temple: How the Federal Reserve Runs the Country (New York: Simon and Schuster 1987), p. 572. The survey was by A. G. Becker Paribas.
This expression of confidence in Greenspan is notable. The comings and goings in Washington are an open book to Wall Street. When Greenspan was not speaking or attending galas, he was working the White House. His biographer Jerome Tuccille writes: “According to several White House insiders, Alan made a point of regularly massaging the people who mattered.”42 Martin Anderson told Tuccille: “I don’t think I was in the White House once where I didn’t see him sitting in the lobby or working the offices. I was absolutely astounded by his omnipresence. ... He was always huddling in the corner with someone.”43 Greenspan’s campaign made an impression on Wall Street, as did his likable disposition. A Fed chairman who gave Wall Street “the opinion you needed”44 and was a director of J. P. Morgan would be apt to see the world from the creditor’s perspective.
The consulting economist orchestrated a media blitz. He made television appearances on the Tod ay show in May 1983 and “The Editor’s Desk” on June 12, 1983.45 The Times profile (quoted earlier) appeared on June 5, 1983. The June 6, 1983, edition of U.S. News & World Report published an interview.46
Also on June 6, Volcker arranged a private meeting with Reagan. In the Oval Office, the Fed chairman told the president: “ ‘This has dragged on too long and you ought to settle it one way or the other.’” Reagan announced Volcker’s reappointment during his weekly radio broadcast on June 18.47 Greenspan wound down his campaign with another “From the Editor’s Desk” appearance on June 19.
Alan Greenspan: Chairman of the National Commission on Social Security Reform
Greenspan was well positioned for a senior position—not only in the White House but also with Congress. He headed a group that reformed social security. This was one of the most delicate political issues during the early 1980s. The argument went that social security was the largest government expense, and the system would be bankrupt by 1984. Social security had to be cut. Taking money away from old people does not win votes. The nation’s elected representatives did what they always do when a difficult decision needs to be made: they ran for the hills and appointed a commission.
42 Jerome Tuccille, Alan Shrugged: The Life and Times of Alan Greenspan, the World’s Most Powerful Banker (Hoboken, NJ.: Wiley, 2002), p. 157.
43 Ibid., pp. 157–158.
44 Martin Mayer, The Greatest-Ever Bank Robbery: The Collapse of the Savings and Loan Industry (New York: Scribner’s, 1990), p. 140
45 New York Times TV listings, June 12, 1983.
46“The LongTerm Boom Now in Prospect,” U.S. News & World Report, June 6, 1983.
47 Greider, Secrets of the Temple, pp. 572–574.
Never one to hop off a fence if he could sit on it, the appointed chairman of the National Commission on Social Security Reform moved the deck chairs sufficiently to delay action for another few years. There was room to think that the commission had succeeded.48 The fix was temporary; as Federal Reserve chairman, Greenspan would once again permit the politicians to avoid responsibility. (This is the subject of Chapter 12.)
The United States continued to buy far more from overseas than it produced. The deficit in goods reached $145 billion in 1986. This was quite a splurge, as were the federal deficit and the debt-stuffed corporate balance sheets.
Alan Greenspan saw dark clouds. This is noteworthy, since, as Fed chairman, Greenspan would say that it did not matter if the United States produced things. In 1984, speaking to the Times, he had taken a more traditional view: “With some urgency, Mr. Greenspan says the recent trend toward short-lived investment means that a higher percentage of the nation’s plant and equipment wears out each year. Thus, a larger amount of investment is needed each year just to replace this depreciated capital stock, and more investment yet is needed to increase the nation’s net capital stock.” Greenspan stated the consequence: “What happens if you have inadequate capital investment, is you wind up with lower standards of living than you otherwise
would.”49
Given his views, Alan Greenspan would seem as well suited as anyone, in an official Washington posting, to warn of a dire future. Instead, he mumbled for 18 years and evaded such discussions.
48 In brief, the commission did not touch the age at which a person is eligible for benefits; it taxed beneficiaries if their income was above a certain level, it required federal employees to contribute to the system, and it retained the formula for adjusting benefits for inflation.
49Steven Greenhouse, “Pitfalls in the Capital Spending Boom,” New York Times, June 3, 1984.
7
Lincoln Savings and Loan Association
1984–1985
Charles Keating’s S&L was the example of how the industry had spun out of control. [Seidman’s italics.]1
—L. William Seidman, Full Faith and Credit: The Great S&L Debacle and Other Washington Sagas
Greenspan was fortunate that his nomination for Federal Reserve chairman preceded the unwinding of Lincoln Savings and Loan. The infamous “Keating Five” scandal was hatched at Lincoln. Five U.S. senators lost credibility in its wake—Alan Cranston, Donald Riegle, Dennis DeConcini, John Glenn, and John McCain. Greenspan was hired by Charles Keating in 1985 to write a letter to regulators on Lincoln’s behalf. The government bailout of the savings and loan industry cost American taxpayers $124.6 billion.2 Lincoln alone cost at least $2.0 billion.3
1 L. William Seidman, Full Faith and Credit: The Great S&L Debacle and Other Washington Sagas (New York: Times Books, 1993), p. 229.
2Different assumptions produce different totals; http://www.gao.gov/archive/1996/ ai96123.pdf.
3 www.fdic.gov/bank/historical/s&l/.
85
Savings and loans (also called “thrifts”) had suffered whiplash from the rise and fall of interest rates. Many were in danger of extinction. Alan Greenspan had warned of their vulnerability in 1981when he told U.S. News & World Report that high interest rates were suffocating S&Ls: they “can only exist in a non-inflationary environment.”4 He told the New York Times “[t]here are now a bunch of moribund cases out there.” Greenspan was not sure if “any” of the savings and loans had equity, but that was not the real problem: “The problem is cash flow . . . there are a number of institutions that are barely able . . . to pay their liability side of the balance sheet].”5
Lincoln before Keating: One of the Best
Managed Savings and Loans
What Greenspan said seems overstated, but there was much truth in it. Notably, his concern did not apply to Lincoln Savings and Loan of Irvine, California. It was run by the Crocker family, which owned 40 percent of the shares. Like most S&Ls, it lost money in 1981 and 1982, but it returned to profitability in 1983 (with the decline of interest rates). Donald Crocker, son of the founder, had nursed Lincoln back to health and was ready to sell. Charles Keating offered to pay $51 million in 1983—two and a half times its over-the-counter market price.6 Michael Milken at Drexel, Burnham helped broker Keating’s acquisition.7
Keating inherited a thrift institution with the lowest ratio of delinquent mortgages of any large thrift institution in California.8 When seeking approval from the Federal Home Loan Bank (FHLB) of San Francisco,9 Keating stated that he would continue with the current management in place and that he would concentrate on California home mortgages. Having received approval from the FHLB, he jettisoned Lincoln’s senior management. Keating would later say he fired them because they were incompetent and that Crocker had told him to do so. Crocker had said nothing of the sort.10 Keating’s new board was not on the payroll of Lincoln. Instead, board members were paid by Keating’s holding company that owned the bank.11
4 “Are Americans Going Too Deep into Debt? Interview with Alan Greenspan,” U.S. News & World Report, August 3, 1981.
5“Talking Business with Alan Greenspan,” New York Times, March 24, 1981, p. D2.
6 Martin Mayer, The Greatest-Ever Bank Robbery: The Collapse of the Savings and Loan Industry (New York: Scribner’s, 1990), p. 171.
7 Martin Mayer, The Bankers: The Next Generation (New York: Truman Talley Books, 1997): “Charles Keating acquired Lincoln Savings and Loan with the help of Mike Milken of Drexel Burnham,” p. 370.
Lincoln, Keating, and Drexel Burnham’s Daisy Chain
A consultant hired to review Lincoln’s books should have looked upon Keating and his connections with some curiosity. Since Alan Greenspan devoted great energy to knowing those who wielded the levers of power, it would have been a strange lapse if he was uninterested in his client. Keating had been executive vice president of Carl Lindner’s American Financial Corporation. Lindner’s reputation rose from the financing boom of the 1960s. Between 1961 (when the company went public) and 1979, American Financial Corporation produced a compound annual return of 19.2 percent.12 During the 1970s, Lindner was an investor in Milken’s early junkbond offerings. In 1979, the SEC had charged Keating with making improper loans to insiders and friends (of Lindner’s Provident Bank of Cincinnati), plus failing to report a pattern of loans to purchasers of assets that Lindner wished to sell. “Keating had consented to a permanent injunction with the SEC, which should have barred Keating forever from ownership of an insured” deposit-taking institution.13
In 1978, Keating had bought a Phoenix house-building company from
9 There are 12 regional Federal Home Loan banks. Lincoln Savings and Loan was in the San Francisco district. Until 1989, the FHLBs were the “principal supervisory agents” responsible for the solvency and honesty of ther local S&Ls. Mayer, Greatest-Ever Bank Robbery, pp. xi–xii.
10 Ibid., p. 171.
11 Ibid., p. 170.
12 Thomas C. Hayes, “The ‘Money Merchant’ of Cincinnati,” New York Times, June 24, 1979, F7.
Lindner. This was renamed American Continental Corporation (ACC). ACC was the holding company that later purchased and owned Lincoln Savings and Loan.14 Keating leveraged it and then expanded into several western cities; all of these efforts failed between 1982 and 1987. Martin Mayer, author of The Greatest-Ever Bank Robbery: The Collapse of the Savings and Loan Industry, wrote: “There is every reason to believe that Keating went after an S&L because he had lost access to other sources of funds and needed government-insured deposits to finance his operations.”15
S&Ls were an attractive platform for a businessman with a certain turn of mind. Deregulation of the industry permitted a panorama of investment classes that had previously been forbidden. William Seidman, who had interviewed Greenspan before his Council of Economic Advisers appointment, learned that “S&Ls could raise nearly unlimited amounts of funds through brokered deposits at low [interest] rates because the money was insured by the government. They could … make their profit on the spread between the low and high rates of interest.”16
Charles Keating needed money. He needed yield from the securities bought by Lincoln. He needed capital gains from the trading of land and securities. He bought the riskiest junk bonds, land, and takeover stocks.17 Keating’s first big investment was $132 million in the common stock of Gulf Broadcast Company. He bought the stock from Lindner’s American Financial Corporation, which had accumulated 19 percent of Gulf Broadcast shares.18
In Securities Markets in the 1980s, Barrie Wigmore wrote that Carl Lindner and Saul Steinberg “ran small insurance companies and dealt repeatedly in borderline investment tactics.”19 In Wigmore’s opinion, the evolution of the pair’s “activities illustrates the combination of native cunning and access to leverage that made them effective.”20 Regarding the relationship of Lindner and Steinberg, Wigmore wrote: “[i]t is tempting to conclude they also represented a cabal, who worked through Michael Milken’s group.”21
14 Ibid., p. 167.
15 Ibid., p. 173.
16 Seidman, Full Faith and Credit, pp. 235–236.
17 Mayer, Greatest-Ever Bank Robbery, p. 174.
18 Ibid.
19 Barrie A. Wigmore, Securities Markets in the 1980s, vol. 1 (New York: Oxford University P
ress, 1997), p. 360.
20 Ibid., p. 356.
When Seidman was appointed to head the Resolution Trust Corporation (RTC)—the agency created to resolve problems in the S&L industry—he faced a mystery: why was the heaviest financial carnage among the largest holders of junk bonds sold by Michael Milken? These included Lincoln; Centrust Savings Bank of Miami, Florida; and Columbia Savings and Loan of Beverly Hills, California. Among them, the three banks held $2.5 billion of junk bonds by the end of 1984—which was equal to 35 percent of the amount held by all mutual funds.22 (William Seidman later wrote that of the more than 900 convictions initiated by RTC enforcement actions, those of the chairmen of Centrust, Columbia, and Charles Keating were “key.”23)
Later in the decade, Seidman’s investigators discovered that Michael Milken had “rigged the market by operating a sort of daisy chain among the S&Ls to trade the bonds back and forth across his famous X-shaped trading desk at his headquarters in Beverly Hills. By manipulating the market, he maintained the facade that the bonds were trading at genuine market prices. . . . When he [Milken] was brought down, and his trading operation with him, so were the S&Ls that depended on the value of his bonds to stay afloat.”24 Of note: the in-house pricing of derivatives, such as collateralized debt obligations (CDOs), was essential to the current financial collapse.
Between 1983 and 1984, Lincoln’s assets more than doubled, from $1.1 billion to $2.24 billion.25 From the time Keating took control of Lincoln in February 1984 through the end of the year, he “had switched virtually all of its activities to real estate development and speculative investments.”26
21 Ibid., p. 346. Wigmore includes one more “old hand” from “the merger wave of the late 1960s”: Meshulam Riklis and his Rabid American Corporation.
Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession Page 10