Predator's Fall

By John Greenwald

"Are the vultures still out there?"

-- Drexel staffer, sneering at reporters as she walked out the door

"Vultures? Look who's talking."

-- Security guard

The final plunge of the most powerful and dreaded firm on Wall Street in the Roaring Eighties came with astonishing speed. Like the abrupt fall of the Berlin Wall thousands of miles away, the collapse suddenly confirmed what everyone in the financial world could already feel in the wind: a new era had arrived. After a desperate three-day search for cash in which it was spurned by its bankers, Drexel Burnham Lambert Group filed bankruptcy papers an hour before midnight last Tuesday.

While only the parent company sought protection under Chapter 11, no one expected the investment firm to rise from the ashes. In an industry that operates on trust and good faith, Drexel had exhausted its reserves. The move meant that Drexel, whose financial wizardry reshaped corporate America and ushered in an age of runaway debt and excess, will swiftly liquidate its business. The 152-year-old titan -- with 5,300 employees and $3.6 billion in assets -- will vanish almost overnight in the biggest failure in Wall Street history.

Drexel's staff got the word in a terse statement from chief executive Frederick Joseph over the firm's intercom. Joseph refused to take questions and quickly signed off, leaving stunned employees to hunt for scarce jobs in an already depressed Wall Street market. Drexel's layoffs, which began Friday, will add thousands more workers to the 37,000 already dismissed by investment firms in the past two years, almost 10% of Wall Street's work force. In a final bitter send-off, the firm's employees, who owned 54% of Drexel's stock, saw the value of their holdings evaporate with the bankruptcy filing.

In the firm's lobby at 60 Broad Street in New York City, security guards searched bags to prevent workers from carting away computers and company records. "People are in a state of shock. They're laughing and crying," said bond salesman Taylor Greene. Retorted a young broker as he stepped into a limousine with one last show of '80s bravado: "I'll enjoy reading about all this from Hawaii."

The echo carried that far and beyond. Drexel's notorious junk bonds -- debt instruments that pay high rates of interest because of the relative shakiness of the ventures they fund -- turned the financial world topsy-turvy and helped set the tone for the money lust that gripped America in the '80s. Armed with the bonds, corporate raiders swiftly raised the money they needed to attack even the largest companies. At the same time, investment bankers raked in billions of dollars by advising the raiders and selling junk bonds to eager borrowers. In what corporate America saw as a glorified protection racket, Drexel and its imitators sold services to targets as well, to help them keep raiders at bay.

On Wall Street the debt-propelled takeover binge gave rise to the era's get- rich-quick mentality. Michael Milken, the deposed Drexel guru who pioneered junk bonds and nurtured them into a $200 billion market, was paid $550 million in 1987 for his unrivaled expertise. In a perverse version of the trickle-down theory, lower-echelon bankers raked in multimillion-dollar salaries, and new recruits with two years' experience earned six-figure sums. The fantastic payoff created a brain drain as the best and the brightest from top colleges and business schools across the U.S. flocked to Wall Street. In 1986 nearly half the senior class at Yale applied for jobs at First Boston, a leading Wall Street investment banker.

Thanks in part to Drexel, the 1980s became the decade of the deal. In 1986 alone, 3,973 takeovers, mergers and buyouts were completed in the U.S., at a record total cost of $236 billion. While some takeovers shook up overly complacent managers and led to useful restructuring, much of the raiding served only to distract corporate America from its real work of improving products and services. In the view of Wall Street's critics, hundreds of deals were done for the sake of the fees and stock payoffs they would generate. This was not the way Wall Street traditionally operated, but in that hotly competitive environment many firms followed Drexel's lead. The resulting riches created a whole new spending culture as Wall Streeters found new ways to dispose of their wealth, buying multimillion-dollar Manhattan apartments, building lavish estates in Connecticut and on Long Island, commuting to work in limos, seaplanes and helicopters.

But now Wall Street's merger machine has run out of gas, largely because corporate America has loaded up with all the debt it cares -- or dares -- to take on. Wall Street is suffering a dearth of deals, but no one is shedding tears for it. The flashy wealth displayed by investment firms has created a backlash on Main Street, which watched with mounting fury as Wall Street got rich through paper-shuffling deals that manipulated companies at the expense of workers and communities. "There's a lot of pent-up anger and disgust with behavior on Wall Street," says Samuel Hayes, an investment-banking professor at the Harvard Business School.

In a TIME/CNN poll taken last week by the firm Yankelovich Clancy Shulman, 63% said Wall Street bankers and brokers could be trusted "somewhat" or "a little" to do what is best for the U.S. economy while 30% said "not at all." Regarding mergers and takeovers, 68% viewed them as "not a good thing" for the U.S. economy and 56% saw the need for more government restrictions on such deals. The corporate debt piled up in the 1980s will be a problem in the next decade, according to 74%, who saw it as "serious" or "very serious."

Drexel's demise was greeted with little sympathy, even on Wall Street. Many experts regard the firm's fall, caused largely by the collapse of its $1 billion junk-bond portfolio, as a just comeuppance and a sign that Wall Street is entering a period of welcome sobriety. Drexel, after all, was more than just a tough competitor; it was viewed as a bad influence. Last year the company agreed to pay a $650 million fine and pleaded guilty to six counts of mail and securities fraud. As part of the settlement, federal prosecutors required Drexel to dump Milken, who now faces a 98-count fraud and racketeering indictment. "The era of extravagance and insanity has come to an end," says economist Pierre Rinfret, who runs a Wall Street consulting firm. "This is a breath of fresh air. Drexel got what it deserved. These guys could destroy the country. There is no rhyme or reason for what has been going on."

As its legacy, Drexel leaves behind a battered junk-bond market and hundreds of corporations staggering under debt. Last week the prices of junk bonds, some of which had lost as much as half their face value in recent months, rebounded as investment firms bought them up to reassure the marketplace about their stability. But in the long run, the overleveraging of America could spell trouble if the country plunges into a recession and profits tumble, leaving companies unable to meet their interest payments.

Junk bonds were a little-known security when Milken opened Drexel's Beverly Hills office in 1978. Seated at an X-shaped trading desk, Milken first peddled junk for small and medium-size companies whose weak credit ratings kept them from issuing bonds that paid lower interest rates. When investors snapped up the junk, Milken expanded the market for his new securities. The tireless promoter argued that the risk of a junk-bond default was scarcely greater than the risk for blue-chip corporate bonds. Since junk securities paid interest rates about six percentage points higher than conventional bonds, Milken found many high rollers willing to buy them.

By the mid-1980s junk had become so popular -- and Milken so powerful -- that corporate raiders could launch a bid backed by little more than one of Milken's trademark letters stating that he was "highly confident" of lining up the necessary financing. Just for the ominous letters, Milken charged fees as high as $3.5 million. Backed by Milken, Texas oilman T. Boone Pickens attacked Gulf Oil in 1984, forcing the energy giant to merge with Chevron and earning nearly $400 million from his seven-month raid. Later Milken bankrolled Carl Icahn in a $1.2 billion takeover of TWA. Supported by Drexel's bonds, the little-known firm Kohlberg Kravis Roberts became America's buyout king, acquiring 35 companies for more than $60 billion since 1976.

Junk bonds proved to be the ideal weapon for exploiting a weakness in corporate America that raiders were quick to detect. They saw that the stock market valued many large companies at prices well below what their assets would fetch if the companies were bought and broken up. By using junk bonds to build their war chests, takeover artists could pay a premium to shareholders and still hope to make a profit by dismantling a target company.

Lured by the seemingly inexhaustible demand for junk-bond financing, Drexel's Wall Street rivals rushed into the profitable business. The newcomers included such prominent firms as Goldman Sachs, First Boston, Merrill Lynch and Shearson Lehman Hutton. While Drexel's grip on the market gradually slipped, in 1985 it controlled more than half of the new issues. "Drexel is like a god," Michael Boylan, president of the publishing firm Macfadden Holdings, declared in a magazine article that a Drexel executive proudly framed. "They are awesome. You hate to do business against them."

For all its power, Drexel had few friends among its colleagues. Even in an industry of flinty-eyed dealmakers, Drexel's way of doing business struck many people as arrogant and smug. "Dealing with them was repugnant," says an executive of Prudential-Bache Securities. "They had this self-ordained attitude of importance. They broke from all the established rules within the underwriting community."

Drexel's most egregious technique was to force companies into unwanted deals, executives say. In one battle that wound up in court, Staley Continental, a food producer based in suburban Chicago, accused Drexel of trying to pressure Staley executives into launching a buyout bid for their company. Before Staley's $220 million suit reached an out-of-court settlement in 1988, the sensational charges were the talk of Wall Street. "They appealed to your greed," says Robert Hoffman, who was Staley's chief financial officer at the time. "And if that didn't work, they appealed to your fear that someone else might take over your company and throw you out."

As Milken's clout grew, financial journalists described him as the most powerful financier since J.P. Morgan. But Milken's penchant for working by his own rules and controlling every situation proved to be his downfall. Drexel's huge profits and free-wheeling methods attracted the attention of federal prosecutors who believed that, among other offenses, Milken fed inside information to a network of traders to manipulate the stocks of his target companies. Prosecutors first snared Dennis Levine, a Drexel investment banker, who pleaded guilty in 1986 to four counts of profiting from insider trading. The Government then got Levine to implicate Ivan Boesky, a Wall Street speculator, who was fined $100 million for insider trading. He in turn agreed to help prosecutors pursue Milken, who had become the ultimate Mr. Big. (Boesky, bearded and gaunt, now resides in a Brooklyn halfway house, where he is completing a three-year prison sentence.)

Armed with Boesky's testimony, prosecutors threatened to bring racketeering charges against Drexel, which would have permitted the Government to tie up more than $2 billion of the firm's capital. Forced to the wall, Drexel agreed to pay the $650 million and give up Milken, who was indicted last March. He was originally scheduled to come to trial next month, but the Government is considering broad new charges that could delay the case.

While the huge fine sapped Drexel's strength, the killing stroke was the severe slump in the $200 billion junk-bond market. Several factors -- a rising default rate, a slowing economy and a new federal law requiring S&Ls to dispose of their junk bonds -- conspired to send the prices of such securities plunging to 50% or less of their face value since last fall. Stuck with more than $1 billion in devaluing junk, Drexel's credit rating began sliding, and its banks cut off credit two weeks ago. The parent company, starved for cash, began to siphon money from the investment firm's coffers until Government regulators halted that maneuver. After a frantic search for a bank bailout or a merger partner, directors of Drexel Burnham Lambert Group agreed to put the company into bankruptcy proceedings.

Drexel executives hurriedly moved to sell off the firm's assets, in many cases at fire-sale prices. Drexel attempted to offer whole departments for sale, including Milken's old junk-bond operation in Beverly Hills, but rival firms turned up their noses at anything that might carry legal liabilities or the taint of scandal. The firm's stockholders will get little or nothing, most notably Belgium's Lambert Group, which owned 26% of the firm and may have to take a $92 million write-off. Creditors include Taiyo Mutual Life, a Tokyo firm with a $70 million claim, and Milken himself, who says he is owed more than $200 million in compensation.

In Washington the Government's top economic team stood by with folded arms and watched the company fail. While Federal Reserve Board Chairman Alan Greenspan and Treasury Secretary Nicholas Brady carefully monitored the situation, the team decided that U.S. financial markets could weather the collapse, in part because junk bonds were already trading near all-time lows. Said an embittered Drexel executive: "What we needed was a pittance, and the Government decided just to let the company go. With a little nudge from the Government, the banks would have put a package together."

Drexel's outcast employees have company in their misery. The firm's crack-up comes amid a flurry of reversals for the highflyers who symbolized the boom time. Last month Peter Cohen stepped down as chairman of Shearson Lehman Hutton, the firm he had built into a Wall Street giant that ranked second only to Merrill Lynch. Like so much that flourished during the hothouse decade, Shearson simply grew too fast. Beset by falling revenues, failing deals and internal disputes, Cohen was forced out by James Robinson III, the chairman of American Express, Shearson's parent company.

The pitfalls of overreaching were on full view last month when the U.S. retailing empire that Toronto developer Robert Campeau assembled in the '80s was placed under the protection of federal bankruptcy court. A hard-driving raider, Campeau had used junk bonds to help finance the $10.2 billion he paid for Allied Stores and Federated Department Stores, whose ten chains include Bloomingdale's, Stern's and Jordan Marsh.

Now investors are watching carefully for signs of weakness in the ultimate deal: the 1988 buyout of RJR Nabisco, which Kohlberg Kravis Roberts, headed by Henry Kravis, acquired for $25 billion. The battle for RJR combined all the excesses of the era, pitting Milken and Kravis against Cohen and F. Ross Johnson, the RJR chairman who stood to make more than $100 million by winning the fight. The victorious Kravis walked off with $75 million in fees alone as part of his prize.

While titans tangled for the last of the megadeals, the ranks of their troops were shrinking drastically in the last years of the '80s. Merrill Lynch, which lost $213 million in 1989, last month announced plans to let 3,000 of its 41,000 employees go by the end of this year. The bleak job outlook deters business-school students who a few years ago might have eagerly aspired to investment-banking jobs. "A lot of people are shying away from Wall Street because the jobs are not there," says Mike Russell, 25, editor of the Harvard Business School newspaper. "There is an air of uncertainty about the Street. People aren't convinced of the financial returns and are worried about job security."

The new hot-job category for many students is "turnaround consulting," which develops the skills to rescue troubled companies -- including overleveraged firms that have been through the takeover wars. The new heroes are turnaround specialists like Sanford Sigoloff. Long known as Ming the Merciless for his fierce cost cutting, Sigoloff now runs the bankrupt U.S. operations of Australia-based Hooker Corp., which loaded up on debt to acquire the B. Altman and Bonwit Teller department-store chains.

Not to be outdone, Wall Street's investment bankers are lining up for their share of the money to be made from the wreckage of the '80s. Observes Robert Reich, professor of political economy and management at Harvard's Kennedy School of Government: "Much of the impetus behind the leveraged buyouts was to bust up companies that were frantically put together in the '70s. Many times it was the same investment bankers and lawyers who then proceeded to take them apart in the '80s. In the '90s these same teams will work on reducing debt loads to strengthen core businesses."

The takeover fevers that racked the '80s have already begun to abate. The total number of U.S. mergers and acquisitions plunged 14% last year, to 3,412 deals, and is now declining at a brisker rate. Only 165 transactions were completed last month, down 56% from January 1989. "The big-fee merger and acquisition game is pretty much over," says Donald Ratajczak, director of the Economic Forecasting Center at Georgia State University. "There are still going to be deals, but nothing like we saw in the '80s."

A prime reason is the severely depressed state of the junk-bond market, where shell-shocked investors are wary of buying new issues. Of nearly $300 million in bonds that were scheduled to be sold this month, virtually every offering has been canceled or postponed. Without the ability to tap the junk market, would-be raiders will no longer be able to take aim at substantial targets.

For corporate executives, that prospect should bring a feeling of relief. While raiders argue that takeovers have made corporate America more productive and efficient, managers call the threat of attack a nerve-racking and costly distraction that inhibits their ability to focus on long-term growth. Each argument has its merits, but after a decade of relentless takeover bidding, debt is becoming a dirty word and raiders have lost their prestige.

In the 1990s corporations will continue to be bought and sold. But the deals will reflect old-fashioned values, like the strategic compatibility of companies with one another, rather than the profits to be made from doing a deal. "The whole system got out of whack," says Myron Lieberman, a senior partner of the Chicago firm Altheimer & Gray, which has specialized in buyouts for 25 years. "We just threw out considerations of how we were going to make the new companies healthy."

For Roderick Hills, a Drexel director and former chairman of the Securities and Exchange Commission, the deepest threat posed by the investment firm's collapse may be the fervor for regulation it inspires. As Hills told TIME correspondent Richard Behar, "The inevitable result of a significant financial failure is that somebody thinks they can pass a law to stop another one. And it's just as inevitable that the law they pass does more harm than good. I doubt that there are any broad legislative lessons to be drawn from the Drexel experience, and I fear that our Congress will try to draw them."

While Congress has been eager to investigate debacles like Drexel's, it has shown little interest in enacting new laws to curb financial markets, even after the 1987 crash. The real lesson of the fall of the most money-mad firm of a money-mad decade is that in any free market, a heedless competitor can lead virtually the whole industry astray. The pendulum is swinging back now, but the impact of the debt that Drexel's junk bonds loaded on corporate America will not vanish as swiftly as the perpetrator.

With reporting by Mary Cronin and Thomas McCarroll/New York and William McWhirter/Chicago