Junk bonds
Definition High-risk, high-yield securities
During the 1980’s, junk bonds helped fuel the frenzy of cor-
porate mergers and acquisitions by producing the enormous
amounts of capital required for companies to purchase other
companies.
Bonds are financial instruments issued by public
and private entities that promise to repay the princi-
pal invested plus interest on or after a specified date.
Brokers rate bonds based upon their trustworthi-
ness, that is, the likelihood of investors actually re-
ceiving the promised return-on-investment. Bonds
with assured returns are rated “A,” while riskier ones
are rated “B” or even “BB.” Low-rated bonds may be
issued by start-up or expanding companies, which
will be unable to repay their debts unless their busi-
ness ventures are successful. To convince investors to
take higher risks on their bonds, such companies of-
fer greater rates of return than those available to in-
vestors in A bonds.
As the U.S. economy improved during the 1980’s,
the public looked for lucrative investment opportu-
nities. Stockbrokers sold B bonds directly to individ-
ual investors wishing to play the market. By 1984,
“junk bonds,” as B-rated offerings were labeled, were
offering double-digit rates of return. Start-up com-
panies sold junk bonds to fund their initial opera-
tions. Large firms like Dean Witter and Paine Webber
began selling them, and Drexel Burnham Lambert
had been brokering junk bonds since the 1970’s. By
the 1980’s, Drexel was the leader in junk bonds,
which had generated significant wealth for the com-
pany. Even Savings and Loans (S&Ls) bought junk
bonds as investments, because federal law could be
interpreted to mean their speculation was insured
against loss.
New tricks were improvised: Junk bonds financed
hostile takeovers over one company by another,
sometimes termed a “corporate raider.” Raiders sold
their own junk bonds to raise the money necessary
to buy controlling shares in their target companies.
Once in control, raiders divided acquired compa-
nies and sold off their various components, paying
back bond holders while netting a large profit for
themselves. This practice put both management and
regular employees of the scavenged companies out
of work. A variation on this approach was called
“greenmail.” The greenmailer bought controlling
interest in a company but offered to sell it back at
more than its market value. If this arrangement was
agreed to, everyone kept their jobs while stock-
holder dividends plummeted.
T. Boone Pickens and Saul Steinberg were the
most famous raiders of the 1980’s. Some considered
them heroes for making companies more efficient
to avoid hostile takeovers; others saw them as villains
for tearing businesses apart and increasing Wall
Street’s debt. One anti-takeover maneuver em-
ployed by potential targets was to “swallow a poison
pill”: That is, vulnerable companies would issue junk
bonds paying great dividends if the company was
broken up. Raiders would be required to pay those
dividends out of their own pockets, preventing them
from realizing profits and making the companies
unattractive acquisition targets. Another strategy was
to find a “white knight,” a company that would
agree to a friendly merger with the target company,
thereby forming a new company that was too large
to raid.
In 1986, financer Ivan Boesky was accused by the
Security and Exchange Commission of getting in-
sider information about unannounced takeovers.
He wore a government wire to incriminate others—
especially Drexel executives—who were funneling
him information and secretly buying stock for him.
Boesky served two years in prison. Michel Milken,
the Drexel junk bond executive, also served two
years for dishonest dealings. Both left prison wealthy
men, Milken a billionaire.Impact By 1989, the junk bond flurry was over.
Congress forced S&Ls to divest themselves of junk
bonds. So many were on the market, there were no
buyers. Junk bonds made billions of dollars for en-
trepreneurs, funded some start-up companies but
destroyed others, and induced companies to merge
and grow larger.Further Reading
Bruck, Connie.The Predator’s Ball. New York: Pen-
guin Books, 1989.
Stewart, James B.Den of Thieves. New York: Simon &
Schuster, 1992.
James PauffSee also Black Monday stock market crash; Busi-
ness and the economy in the United States;Wall
Street.The Eighties in America Junk bonds 557