The Fall of Drexel Burnham Lambert and the Israeli Connection

By Richard H. Curtiss

''Throughout the rise of the junk bond market, there was always a dark undercurrent of anti-Semitism at work: There is never any question that Milken and the highly visible junk bond raiders he financed were mostly Jewish. Neither is there any doubt that their targets were usually companies run or owned by WASPS."

— David Warsh, Washington Post, Feb. 21, 1990.

"When goyim kill goyim, they hang the Jews," Israeli Prime Minister Menachem Begin complained after the 1982 massacres at the Sabra and Shatila Palestinian refugee camps. His statement ignored the fact that immediately after the evacuation of PLO fighters under American protection from West Beirut, the Maronite Christian militiamen who slaughtered the families they left behind were transported to the camps in Israeli military vehicles, wore Israeli-supplied uniforms, used Israeli ammunition, and were provided covering fire, illumination flares, food and water by the Israeli soldiers who surrounded the camps and kept their occupants penned in for the slaughter.

There will be similar charges of anti-Semitism on revelations of the devastation of America's economy, jobs, savings, and competitiveness wrought by the junk bond scam conceived by Michael Milken and carried out by his employer, Drexel Burnham Lambert Group Inc. Such revelations have the potential to create more anti-Semitism in the United States than the combined activities of the American Israel Public Affairs Committee which has picked close to $50 billion from American taxpayer pockets for Israel, and the 100-plus deceptively named political action committees which are foundation blocks in the wall of corruption that PACs have erected between members of Congress and the constituents they no longer represent.

It's a subject approached gingerly in Jewish weeklies around the US, hardly at all in the mainstream American press, but openly and bitterly in the stagnating factories and devastated executive suites of corporate America. There may eventually be similar bitterness among American Jews who realize the direct Israeli connections to the devastation.

The subject is obvious to regular readers of the Israeli press, but still too sensitive for open discussion in the US, even in publications edited for an all-Jewish readership. It provides a textbook example of why unquestioning support for Israel by organized American Jewry is a disaster for both.

The David Warsh article in the Feb. 21 Washington Post business section quoted above defines the problem:

There are two broad schools of thought on what Milken wrought. Each has something to recommend it. One, pushed by Milken, the Wall Street Journal's editorial page, various corporate raiders and not a few economists, is that access to institutional money was instrumental in restructuring American industry, putting it back on its toes, bringing into existence strong new branches of the productive apparatus. The other view is associated with the government's prosecution of Milken, corporate executives and author Connie Bruck, whose superb 'the Predator's Ball' is the indispensable first draft of the history of Milken. It holds that the junk bond business was essentially a fast moving con game, quickly built with the help of a series of criminal acts. What the ensuing collapse of "what Milken wrought" will do to American interest rates is described by H. J. Maidenberg in the Feb. 20 New York Times: "While the credit market appears to have weathered the collapse of Drexel Burnham Lambert Inc ... the full fallout from the bankruptcy is likely to include higher interest rates."

What the acts that led up to the bankruptcy did to long-term American competitiveness is described by Jerry Sterner, a former real estate investor from Brooklyn whose off-Broadway play, "Other People's Money," is packing in Wall Streeters:

In corporate America now, we can't spend money on the necessary things like research and development. We're too busy meeting the interest payments on our leveraged deals.

How about jobs? Starting close to home, Drexel Burnham Lambert, which had a pre-bankruptcy workforce of 5,300, has let 3,000 go in the United States and 200 in England. Those lost jobs, however, are miniscule compared to the hundreds of thousands of jobs already or soon to be lost because of the plant closings and corporate failures across the United States resulting from junk bond-financed "leveraged buyouts" by corporate raiders. Odd snippets of news help define the scale of the dislocations. Peter T. Kilborn reported in the Feb. 25 New York Times:

In an effort to prevent plant closings and resulting layoffs, union leaders and a new investment firm said today that they are forming a fund to help workers buy factories ... The fund was announced at the annual gathering of the leaders of the A.F.L.- C.I.O., which has become alarmed over the jobs lost in the wave of corporate buyouts and plant closings in recent years.

A Direct Connection

As for the connection to the failure of savings and loan institutions all over the US, it's clear and direct. Wrote Henry Kaufman, president of a leading New York money managing and financial consulting firm in the Feb. 23 New York Times:

The demise of Drexel Burnham Lambert Inc. has been portrayed as the end of an era, and in many ways it is. But it also marks the beginning of a new, darker era in which Wall Street and the nation will pay a heavy price for the excesses of the last decade. Drexel Burnham's collapse is symptomatic of a deeper problem: the abuse of the American credit system. The consequences of this abuse now abound. Hundreds of savings and loan associations will have to be closed down, costing taxpayers hundreds of billions of dollars. Many other financial institutions have been significantly weakened by poor-quality loans and investments...

The end of Drexel Burnham does not mean the end of the unwinding of the financial recklessness of the past decade. Continued slow economic growth or a business recession will bring forth failures that are still hidden in the financial fabric.

David A. Wyss, chief financial economist at the DRI-McGraw Hill economic consulting firm, was equally pessimistic:

"Drexel was the most heavily involved player by far in the junk market. I can see maybe a half-dozen other financial institutions that could be in serious trouble." He listed Los Angeles-based Columbia Savings and Loan and the First Executive Insurance company. Both are large issuers and holders of junk bonds.

Pension Funds At Risk

Not even corporate pension funds are immune from the disaster. The Department of Labor reports that of $1.7 trillion in private pension assets, between 3 and 5 percent are invested in junk bonds. That means between $51 billion and $85 billion in private pension funds are presently at risk.

The trail that led to the unraveling of Drexel Burnham Lambert began with one man's pattern of extremely profitable investments in the stocks of companies that shortly thereafter became the targets of hostile takeovers. As his client's stocks soared, his broker guessed that the purchases were based on insider information, and began quietly placing similar orders for himself. So did others, and the widening pattern of identical, and extraordinarily successful, investments attracted the attention of Securities Exchange Commission investigators. They traced the information to a young broker named Dennis Levine, who admitted illegally exploiting information he obtained while assembling financial backing for corporate raiders. The subject is obvious to regular readers of the Israeli press, but still too sensitive for open discussion in the US ...

Levine had passed the information to friends, who bought stocks for Levine and themselves. He also sold the information to Ivan Boesky, a phenomenally successful arbitrager and investor, who, investigators discovered, had been paying Levine and other Wall Street insiders for the illegally-obtained information upon which he made his investment decisions.

Boesky, a prominent figure in New York Jewish circles because of his legendary generosity toward Israeli charities, in turn fingered the other sources of the information upon which he had built his reputation as the "great white shark" of Wall Street. He led SEC investigators straight to Drexel Burnham Lambert.

Charity Begins at Home

At this point, guarded articles in the American Jewish press nervously focused on possible causes and effects of the obvious fact that most of the principals in this largest-ever insider trading scandal were Jewish. A careful examination showed, however, that his public support for Israel, rather than being Jewish, was the key to how a figure of Boesky's prominence could, over a long period, corrupt so many Wall Street insiders without in turn being subjected to extortion or exposure.

He had selected as potential collaborators fellow Jews identified with pro-Israel charities. A recipient of his illegal overtures who might turn out to be too honest to accept Boesky's offers of money or stocks for insider information very likely would also be reluctant to report such an illegal proposition by an ardent, generous, and prominent supporter of Israeli causes. To do so might turn the informer into a pariah in what the Jewish press calls "the pro-Israel community."

Entrapped himself, however, Boesky implicated Drexel Burnham Lambert's rising star, Michael Milken, who had personally pocketed more than $1 billion while working with the firm, $550 million of it in 1987 alone. Boesky turned him in despite the fact that Milken was known as a man who had distributed millions of dollars to Israeli charities through his Milken Foundation.

In his Washington Post article, David Warsh summarizes how Milken operated following the May, 1975 deregulation that broke up a Wall Street monopoly by "traditional white-shoe firms run by Ivy League graduates from America's first families of finance." Warsh writes:

One of the most determined and inventive musclers-in was a bond salesman named Mike Milken. A Wharton School graduate, Milken started selling low-grade investment bonds ... in the early 1970s for Drexel Firestone, the WASPish firm that would in time become Drexel Burnham Lambert. By the end of the 1970s, he was successful enough to move his operation to Beverly Hills. . .

When tax law changes in the early 1980s gave a powerful new impetus to debt financing, Milken was in a unique position to take advantage of it. Within a few years, almost single-handedly, he created a new portion of the spectrum of the American capital markets by persuading big institutional investors to lend money to corporations that had previously been unable to borrow, and persuading Wall Street mainstays like Salomon Brothers and First Boston to join him in the junk bond underwriting business. He made a personal fortune doing it-and he made a financial powerhouse of Drexel Burnham Lambert.

Reports Robert J. McCartney in the Feb. 14 Washington Post:

Drexel's Michael Milken created a new use for junk bonds in the 1980s, persuading executives to issue them to restructure their companies and speculators and investors to buy and trade them. Much of the great increase in indebtedness of US corporations during the past decade is due to junk bond holdings. Under Drexel's leadership, the amount of junk bonds on the market swelled to $200 billion nationwide, and the bonds became an important underpinning of pension plans and a popular mutual fund investment...

Now some are paying the price. As the value of junk bonds has fallen over the past year-because of Drexel's problems, the stock market's slump and the economy's slowdown-the institutions have been forced to mark down the value of their portfolios ... That process could lead to bankruptcy for a few institutions.

Washington Post writer Steven Pearlstein illustrates how far those portfolios may have to be marked down with the example of the April 1988 purchase by Milken and other Drexel associates of all of the outstanding stock of Rexene Corporation, a small chemical manufacturer, for $6 million in cash and $450 million in borrowed funds. As the price of chemical stocks rose, the Drexel investors "took the company public,'' selling some of its shares to investors on the New York stock exchange for $500 million, all within three months of the takeover. A year later, the Drexel investors took out another $120 million as a cash special dividend. Meanwhile, 10 percent of the company's work force was laid off. The company's stock is now selling at one seventh of the price investors paid when it was taken public by Milken and his Drexel colleagues. Phoenix real estate developer Charles Keating, whose campaign contributions have triggered Senate Ethics Committee investigations of five US senators charged with intervening in a government investigation of his Lincoln Savings and Loan, purchased that now defunct institution in 1983 with $50 million raised by Milken through the sale of junk bonds.

Up 5,300 Percent

From then on, both were collaborators, with others, in daisy chain transactions to increase the value of such securities. In December 1986, Drexel sold Lincoln 2.1 million shares of stock in Playtex Corp. for 20 cents a share. Four months later, Lincoln sold the shares to its parent company, American Continental Corp, for $1 a share. In December 1987, ACC sold the stock to CenTrust for $6.94 a share. In June 1988, ACC bought the same stock back for $10.60 a share. Because there was no public market for the stock, its value was set each time by Drexel, which was legally obliged to set a fair price. Because Drexel had secretly purchased part of ACC, without disclosing the investment to the SEC as required by law, it was not a disinterested party to the transactions which, in only 18 months, inflated the value of the stock 5,300 percent, from 20 cents to $10.60 a share.

The Defaults Begin

The stock of another Drexel client, Memorex NV, a computer and recording tape manufacturer, went through a series of ACC and Lincoln transactions that took it from $2.8 million to $13.3 million in less than two years. Drexel, and Keating's Lincoln Savings and Loan, were involved in the financing of Revco Drug Stores, the first major leveraged buyout to default on its obligations, and of the now bankrupt Campeau Corporation, which is selling its recently acquired chains of well-known US and Canadian department stores to cover its debts.

Economist Hobart Rowen summarized the debacle in a Feb. 18 article in the Washington Post business section:

The $200 billion junk bond market that Michael Milken launched in the early 1980s helped finance the wave of corporate takeovers that froze American industry in its tracks, shuffling paper to avoid hostile buyouts, while West Germany and Japan were attending to the mundane business of making quality goods and merchandising them. At risk today is the entire financial system, including not only the wretched savings and loan industry but commercial banks and overextended corporate borrowers.

Conviction of Levine and Boesky, and indictment of Milken on felony charges, was not the last chapter in this sordid story, however. Nor was the agreement by Drexel to pay $650 million to the federal government as part of a settlement of six felony charges to which it had pleaded guilty. There is one last item, which the Washington Post, in a Feb. 22 editorial, described as "one for the Guinness Book of World Records—and the courts. " As Post columnist Haynes Johnson reported the story on Feb. 23:

In its final days, Drexel made the rounds of banks seeking a loan to stave off bankruptcy. The amount it sought was $350 million. Now we learn that it was exactly the amount that Drexel paid in bonuses to its top executives in the weeks before its bankruptcy. Some of the bonuses ... reportedly totaled as much as $20 million for some executives ... What a fitting footnote to the legacy of greed and arrogance exhibited on Wall Street.

There is, however, another footnote to the chain of disasters eating into the financial system upon which millions of Americans depend for jobs pensions, and the credit they need to buy houses and automobiles and put their children through college.

That footnote, as yet unpublished in the United States, leads directly to Israel, and the apparently altruistic feelings for Israel entertained by the otherwise self- obsessed Milken and other Drexel officers.

Among major securities that even Drexel’s rapidly orchestrated churning couldn't make alluring to American investors were those from Israel. In Israel's largely socialist economy, basic industries are owned not by the government, but by the Histadrut, Israel's trade union movement. It is politically entwined with the Labor Coalition, presently headed by Defense Minister Yitzhak Rabin and Finance Minister Shimon Peres. The Histadrut controls Koor Industries, a complex of basic manufacturing enterprises, nearly all of which, like the farm collectives called kibbutzim, would be bankrupt without annual Israeli Government subsidies.

Drexel spent millions on the stocks of Koor-directed firms, but found that they have little but sentimental value to American Jewish investors, and none at all to others. These ill-advised purchases were a major factor in the chain of failing dominoes that eventually led to Drexel Burnham Lambert's bankruptcy.

In an angry Feb. 22 editorial entitled "Drexel Eats the Golden Goose," the Washington Post said of the company's executives: "It's hard to know which explanation is more shaming. Either they didn't know the financial condition of their firm, in which case only fools would have paid out such gigantic bonuses. Or they did know and paid the bonuses anyway, in which case the word that comes to mind is knaves. "

Another explanation, however, is that the principals at Drexel Burnham Lambert knew very well what they were doing to their clients, employees and fellow Americans. It appears, however, that they only cared about themselves, and Israel.

To Americans, and particularly to any American Jews who knew what was going on but were reluctant to blow the whistle, they certainly look like knaves. But to Israelis they may look like heroes, and the rest of us Americans, Jews and Gentiles alike, must look like fools.

Richard Curtiss, a retired Foreign Service information officer, is chief editor of the Washington Report on Middle East Affairs.