Madoff Is Milken Do Over

Many of you will not recall the name of Michael Milken.  He was a very high flying Wall Street Master of the Universe in the ’80’s.   He ended up going to prison for a few years.   From what I was able to read in the papers at the time I was never sure if he had really committed any crime.  There are a couple of biographies about him and I would highly recommend you read one of them.  Everyone always thinks that there is something new under the Sun but they should read Leviticus and they would realize that for millenia that belief has been proven wrong over and over again.

Milken was a broker.  He was with Drexel, Burnham Lambert if my memory serves me correctly.  He studied the markets and was always looking for a new way to create wealth, make sales and find a market that had not been exploited or fully exploited.   He focused on mortgages.  For decades they had been considered the stogiest of investments.  Mostly they were made by Savings and Loans to home buyers and then the S/L would hold the mortgage till maturity and make its profits off the difference between the interest it paid out to depositors with savings accounts and the interest they could collect on the mortage.  It was a pretty boring but safe business model and had worked successfully for decades.  The mortgages and the S/L business was a sleepy back water of the financial world.  They were almost all profitable but the returns were never eye catching.   No one on Wall Street promoted investing in either the mortgages or the S/L’s at that time because they were low return.  Like driving a good old dependable Chevy.  It would get you there but it wasn’t a Cadillac.   Milken began to look where others hadn’t really dug before.  He realized that those mortgages represented a cash stream for future years.  That cash stream could be discounted and converted to cash right away for a price.  He came up with the idea of “stripping” those interest payments out of the mortgage payments being made on the basic 30 year mortgage.   Similar ideas had floated around before but he worked it harder.   He found that indeed there were those who would like to invest in that cash stream.  He created a new product and mini industry dealing with the cash flows from mortgages.  He sold his investment vehicle to others and got fees on each sale.   The investors had the steady flow of money coming into their coffers for years to come.  Of course the whole thing was dependent on interest rates for the mortgages and in the general market place being predictable and steady.   Sharp inflation or deflation would skew the numbers and turn a good investment into a loser.  That risk was supposed to be factored in when determing the discount to put on the mortgage in the first place and it was.  But the future has a funny little habit of not turning out the way the Masters of the Universe predict or that economist predict or even the sophisticated Wall
Street gurus.

I have greatly over simplified that system he was using and that is why I encourage you to read for yourself.  I have tried to give the essence of his strategy and the strategy that he employed to make millions. He became very, very rich.  Then of course things went sour.   People lost money on their investments with him.  The real estate crash of the late ’80’s was the undoing of his scheme.  Suddenly all the numbers that had been used to predict profits and cash flows were wildly off.  There was a great hue and cry from the investors.  Just as there was a great hue and cry from Washington about the Savings and Loan crisis.  Politicians got more involved and naturally were looking for scapegoats to cover their trail.  The public pressure was enormous for “someone”, anyone, to be held accoutable for the problems and loses.  Milken was there and an easy target.  To this day I am not sure if he committed any kind of crime at all other than making lots of money in real estate, even though the real estate deal were once removed because he dealt in sophisticated securities that were supported by real estate loans.    The flood tide of opinion was against him and many of the Savings and Loan execs at that time.  The mob demanded “justice” and the politicians  were only to happy to push for prosecutions to divert attention from their own behavoir–see Jim Wright and Rostenkoski. (They are both another story from that era.  Each a former Democratic speaker of the House, one to prison the other run out of town in ignominy.)

People more often than not will believe what they want to believe in the first place.  His basic idea was sound but all the moving parts had to work right.  They did work right for a while.   I have no idea what Madoff has done other than what I see in the news.   Those accounts do make it appear he was pulling a classic and not particularly creative Ponzi scheme.  It was merely large and complicated with paperwork.  So many now are calling for the heads of many on Wall Street.  I have heard some of the pundits say that Thain or others like him should be behind bars.  Geez, talk ab0ut a rush to judgment!  I am not defending anything wrong those on Wall Street may have done but I would like to see more distinctly exactly what they have done that is  criminal.  If real crimes were committed then pursue them by all means.  But I think the sign on the city limits of Washington is beginning to read Salem.   Not so much because of Madoff but due to the widening net of suspicions and accusations and the bloodlust to punish capitalists.

Czar, Tzar and Kaiser are all words that derive from the Latin for Caesar.  That influence from Rome moved deep  and wide throughtout the subsequent history of the West.

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