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Michael Milken On The Five Biggest Systemic Threats

Tyler Durden's picture




 

Time to start loading up on those sovereign CDS. Today Michael Milken provided some insight into what the five key reasons for our current predicament are, which, courtesy of absolutely no real reform, double as even greater future risks for the global financial system. These include: i) that corporate credit is not the same as leverage, especially not 100x debt/EBITDA, ii) mortgages in real estate are never an investment-grade asset, iii) interest rates are volatile and unpredictable [the JPM-GS IR swap complex will not be too happy to hear this], iv) The US AAA rating is misleading and, and most important, v) sovereign debt is a big, if not the biggest, risk.

Full highlights of Milken's presentation, courtesy of Deal Journal:

Credit rather than leverage

When I was on Wall Street , I rarely had ratio higher than 3:1 or 4:1, I have never heard of any leverage ratios higher than 10:1. But in the United States of America, there were companies that leveraged 100:1. To me, it is not a business.

Mortgages in real estate are never an investment-grade asset

Real estate values go up 70 years and in certain period of time, it has been going down for five years in a row. If you are an investor that buying real estate assets that are backed by mortgages, assuming the only way to get your money back is hoping the price keeps to go up, then it is hard to understand what the asset category is. The debt depends on the asset value that the company who sells the debt doesn’t guarantee.

Why aren’t other countries having this problem? Because in most countries, people don’t borrow on their homes. The shocking thing for America is that this occurred before. In 1980s, we went through 5-6 painful years that caused failures or mergers of almost every single financial institution in Texas, Colorado, Oklahoma, Louisiana and Arkansas. In Houston, house prices fell 40% in five years.

Interest rates are volatile and unpredictable

I have never met anyone of significant wealth who made money guessing which way interest rates are going over a long period of time. In 1981, when short-term rates were 20%, almost every single financial institution, including the most conservative, was underwater on their government portfolio, when the U.S. government bond was sold at 50 cents on the dollar.

Rating is misleading

I guess none of the financial crisis would have happened without rating. There are now only four AAA-rated companies left in the America now: Microsoft, ADP, ExxonMobil and Johnson & Johnson.

Yet, S&P alone, in the first eight years of this century, has rated 17,000 securities AAA. How do you lose a 100% on a triple A investment? Well, first, those weren’t AAA companies. Second, you can borrow against it and create a security that is against the mortgage portfolio that is still rated as triple A. That is nothing new. If you read the rating history you will see that a double-A railroad has a 200% higher default rate than a B-rated industrials.

Sometimes, companies were not getting downgraded after they actually defaulted. Even for GM, there was an uptick in its ratings in last May from B- to B.

So if you are relying on rating, then I am not sure why, as a money manager, you should be paid a fee because there isn’t too much value-added you are providing. Besides, people who provide ratings are just human beings. Maybe if they are the most talented in the world, you would have already hired them.

Sovereign Debt is a big risk

It isn’t a major issue in the market today and was not a main reason that caused this crisis , but historically, it is among the worst credit assets in the world.

In 1980s, people constantly told investors “No one ever lost money by loaning money to a country.” But the U.S. only got 30 cents on the dollar from a sovereign loan to Poland. The loss in sovereign loan totaled $1 trillion in those years, but investors continued to believe these assets aren’t risky. This dramatic example tells us that people in senior positions, such as those in the Fed and run major banks, make statements that are just 100% false.

One extreme example is Argentina. The country, in the past century, has issued loans that borrowed at 100 cents on the dollar and paid 30 cents on the dollar back. In 1980s, Bank of America lent almost all its capital, $700 billion, to Argentina. Eventually, that debt was restructured at 30 cents a dollar.

American investors vowed not to loan money to Argentina ever again . Years later, the U.S. loaned $100 billion to Argentina. History repeats itself. That is why investors need to base their work on research, not on conventional thinking.

 

 

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Thu, 11/05/2009 - 23:19 | 121762 JamesBrrando
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well said!

Thu, 11/05/2009 - 23:29 | 121770 SloSquez
SloSquez's picture

"Maybe if they are the most talented in the world, you would have already hired them."

Statements like this just raise my ire.  What part of "you can't apply calculus to markets" do people not understand.  Models in the financial world are only guidelines.  It's hard enough to apply models to things that are real.  Markets are not.  The world would be much better off if the financial types would quit talking about stuff they don't understand.

Thu, 11/05/2009 - 23:49 | 121789 Rama V
Rama V's picture

"It's hard enough to apply models to things that are real.  Markets are not. "

Are you saying that markets are not real or that markets are not hard enough for models?

Fri, 11/06/2009 - 00:19 | 121813 SloSquez
SloSquez's picture

Markets don't behave relative to any known.  Unless you control the market, markets cannot be modeled into the future with any certainty.  It's the same reason the weatherman is only good for a few days.  Too complex and all the variables cannot be accounted for.  To answer your question, markets are real and models cannot predict, no matter the complexity of the model. 

Fri, 11/06/2009 - 09:38 | 122042 Gunther
Gunther's picture

Nice analogy of market and weather. I do not know of any mathematical model that predicts a market or the weather for any longer period of time.

But for the weather are weather proverbs that are correct in two out of three cases. For the market, DOW Theory claims to be correct seven out of ten times in forecasting the trend.

 

 

Fri, 11/06/2009 - 00:09 | 121805 Anonymous
Anonymous's picture

O....k.... and Milken is the one who orchestrated a bubble by introducing junk debt as a 'grade A+' investment

His point is moot.

Fri, 11/06/2009 - 00:14 | 121809 Banker1944
Banker1944's picture

Milken's musings are compelling, so is the fact that he served time for financial misdeeds.

Fri, 11/06/2009 - 00:23 | 121817 Anonymous
Anonymous's picture

Al Capone called it right in the 20s - he said wall st was 'a racket" - Milken was a wall st. mobster and he knows of what he speaks--I find his views particularly credible since he has nothing to lose. Scary views, but credible -- fits right in here. Thanks for the post

Fri, 11/06/2009 - 09:47 | 122060 E pluribus unum
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"Was"?

Fri, 11/06/2009 - 00:26 | 121823 Anonymous
Anonymous's picture

Michael Milken is one of the biggest scum bags on Wall Street.

Fri, 11/06/2009 - 09:10 | 122022 Gordon_Gekko
Gordon_Gekko's picture

Compared to Goldman Sachs he is practically innocent.

Fri, 11/06/2009 - 09:53 | 122073 heatbarrier
heatbarrier's picture

Prince of the Realm.

Fri, 11/06/2009 - 00:33 | 121827 JohnKing
JohnKing's picture

He forgot the biggest systemic threat:

Assholes like him.

Sun, 11/08/2009 - 15:37 | 124004 Problem Is
Problem Is's picture

+100...

Hey, that is a convicted felon "philanthropist," currently manipulating cancer drug stocks through his "charitable" foundation... you are talking about!

Milken has a new book coming out:

"How to Defraud the Public out of $1 Billion, Face a 98 Count Felony Indictment, Hide $400 million Stolen Funds in My Wife and Children's Names, Play Tennis at a Country Club Prison For 22 Months, Become a "Philanthropist," Manage My Wife's Stolen Money and Manipulate Stocks, Even Though I am a Convicted Felon Banned From Wall Street For Life, Without Really Trying."

I am getting it on Kindle...

Fri, 11/06/2009 - 00:59 | 121855 Anonymous
Anonymous's picture

Perhaps you should read Daniel Fischels account of Milken taken from the actual court transcripts. The book is called Payback. You will note after reading it that there are many scumbags, the biggest ironically is none other than Rudy Giulliani. I would not count Milken as one of them.

You will also note a long held Wall Street tradition of using the government to destroy your competition especially if he or they have a huge competitive advantage. You should read this book and compare how many were destroyed by creating laws that were applied retroactively. And you might also compare the current situation and the the astonishing difference in punishments.

Milken was one of the most insightful and brilliant market players of his day. His recognition of the role debt played in capital structures and in managements behavior revolutionized the market and allowed for some terrific opportunities to make and lose fantastic sums of money.

So it is ironic looking at Wall St. today, CNBC and congress amongst so many others and call this man a scumbag. At his worst he looks like a saint compared to this lot.

Fri, 11/06/2009 - 09:15 | 122019 Gordon_Gekko
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"there are many scumbags, the biggest ironically is none other than Rudy Giulliani"

Funny, I was gonna say the same thing. He was targeted because he was not part of the Wall Street "Club" (he operated mostly as a lone warrior and had moved to California early in his career) and because Giuliani wanted to fulfill his political ambitions. The Wall Street "club" firms ala GS et. al. could not see someone becoming more successful than them and cutting into their share of the pie. In fact, I suspect Giuliani was explicitly ORDERED to "contain" him, his reward being political ascendancy. Giuliani is the real ASSHOLE.

Fri, 11/06/2009 - 01:08 | 121858 RozzertheDropsky
RozzertheDropsky's picture

Hey, go easy on Michael. Paid his debt to society. He's from the "classic era" of Wall St. hucksterism - Boesky, et al. We wouldn't have had Gordon Gekko without Michael. Anyway, he's a Cal man. His point about sovereign debt and the usual bromide that the "U.S. can't fail unless everything fails" is especially chilling. Everything has now been shown to be quite fallible. As TD has pointed out, the U.S. has to roll about $3 tril in short term debt during 2010. Things are going to get very, very interesting, and will test that old bromide.

Fri, 11/06/2009 - 02:08 | 121903 Tripps
Tripps's picture

Milken is central to Deep Capture, illegal naked shorting scams, mafia, etc

 

F this guy and anyone who tries defending him

Fri, 11/06/2009 - 02:22 | 121909 Anonymous
Anonymous's picture

Yeah, Milken's a scumbag but if I were in a room with Milken and Guiliani while holding a double-barreled shotgun, I'd do the right thing.

Shoot Rudy twice.

Fri, 11/06/2009 - 09:51 | 122069 E pluribus unum
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If I was in that room with only one bullet, I'd kill myself because there's no way I could ever get that meeting out of my mind unless I was dead.

Fri, 11/06/2009 - 05:47 | 121972 Renfield
Renfield's picture

Michael Milken. I was a teenager in the '80s and I remember him being called the 'junk bond king'. Fraudster. Apparently took down a large number of innocent(?) people for a LOT of money, got a slap-on-the-wrist, sweetheart sentence for turning State's and spilling the beans.

Became a philanthropist, founded a charitable organisation when he was out. That's all I've really heard about him. Is he 'rehabilitated'? Was his light sentence his fault, or the judiciary's?

Either way, I have to admit that if Alan Greenscum, or Robert Rubitard, or either of the Bush tyrants or Obambi or Bermonkey or Larry Fatsummers just TOLD THE TRUTH for a damn change, I'm not saying I'd think they were suddenly saints but I'd give them full credit for telling it like it was.

What if Bermonkey finally broke one day and said, "OK, guys, I was wrong, fuck my damn thesis. This is too important and a bunch of GoldmanSuchs parasites have been taking full advantage of me to run the country solely to fatten their wallets. Here is a list of names. We've been screwing the taxpayer, we've been traitors to our country, we've ended a promising capitalist empire early in its rule. I'm ending this lie here and now, and calling for an end to the Federal Reserve and a return of the currency to its people, beginning with a full audit of the vaults and the books." How would we feel about him then?

Or even: "I'm retiring as of today. I'm out of it now, so I'll tell you exactly what's going on and what the scams are." Even that.

I think Milken deserves credit here. The man once was (is?) a scumbag - but that is a logical fallacy called ad hominem.

What he's saying here, in this particular article, is going into my files. I think he's absolutely right in this piece and I'm grateful that he said it...

Fri, 11/06/2009 - 08:28 | 121998 JohnKing
JohnKing's picture

Became a philanthropist, founded a charitable organisation when he was out. That's all I've really heard about him. Is he 'rehabilitated'?

Read deepcapture and how he uses his "philanthropic" mirage to game the system. Sociopaths are beyond rehabilitation, most psych types are coming to the conclusion that they (sociopaths) simply use the rehabilitation process to hone their nefarious skills.

Michael Milken, 60,000 Deaths, and the Story of Dendreon

Fri, 11/06/2009 - 07:09 | 121983 ft65
ft65's picture

I don't think Milken is telling us something that even the most basic informed investor doesn't know. Milken is eminently qualified to comment on our current situation. It's just a shame it takes a financial melt-down before these  people come out ofv the woodwork.

Aside the Goldman and all the other financial terrorists, along with bought-and-paid-for politicians, the people we should be really angry with is MSM and their corrupt parent companies, who have been lying to us for years.

There needs to be a revolution, and otherwise useless lamp poles should be put to good use, stringing these bastards up.  

Fri, 11/06/2009 - 07:32 | 121991 Anonymous
Anonymous's picture

Here is what Milken purposefully did....

Created "sell-able" junk....

Sell-able because of high mark ups to brokers....

And some "sell-able" commonly known names....

Fri, 11/06/2009 - 09:13 | 122027 Gordon_Gekko
Gordon_Gekko's picture

Ummm...aren't you describing the entire Wall Street's business model?

Fri, 11/06/2009 - 08:38 | 122004 Anonymous
Anonymous's picture

The fact that he engaged in fraudulent activity means that he understands the system weaknesses at their core and can easily reveal them. It's not about who he is or was. It's about insight.

Fri, 11/06/2009 - 09:26 | 122036 Bruce Krasting
Bruce Krasting's picture

Milken shook the trees in the 80's. Made friends and enemies in the process. He backed Boone Pickins in an effort to take over SoCal Petroleum.

That company was well connected in D.C. The rest is history. Things haven't changed much. Big companies still have the clout. Too much.

Fri, 11/06/2009 - 10:16 | 122115 Anonymous
Anonymous's picture

we should have sent mm to the fed, instead of the slammer

Fri, 11/06/2009 - 13:25 | 122390 Anonymous
Anonymous's picture

Sovereign Debt is a big risk...

Just wait a few years and the Banana Republic of America will offer 1 cent on the dollar to the rest of the world. Take it or leave it...

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