The last days of Drexel Burnham
This article was originally published in Fortune on May 21, 1990.
DON’T WEEP for Michael Milken. Though he broke down in court when he had to admit he was a felon, he certainly cut a good deal for himself. In all likelihood he’ll still be plenty rich when he gets out of prison. Contrast that to the dismal fate of his firm, Drexel Burnham Lambert—bankrupt within months of settling similar charges for a similar amount of money. How did so powerful a firm fall so quickly?
At year-end 1988, Drexel Burnham had a brawny $1.4 billion in capital and 50% of junk bond underwriting. A year later its market share had dwindled to 38%, top executives were scrambling to roll over $300 million of the firm’s own commercial paper, and Drexel was hemorrhaging—losing $86 million in one month alone.
Did Drexel do itself in? Or was it done in? The truth is that this was a case of suicide—and murder. So potent had the firm become that employees truly believed they could do whatever they wanted without fear of retribution. That’s why they could threaten FORTUNE 500 corporations with takeovers and never expect political retaliation. And that’s why they could leverage themselves and their clients to the hilt without preparing for the day debt would go out of fashion. Says a former officer: “You see, we thought, ‘We are invulnerable.'”
Management was as misguided as it was self-confident. In the good times, CEO Frederick Joseph and the board of directors were lax supervisors, allowing the firm to be run like a Middle Eastern souk. Milken sat at the center of his X-shaped desk in Beverly Hills and was accountable to no one. Eager for Drexel to become an investment banking powerhouse, Joseph knew better than to tinker with the marvelous Milken money machine he needed to finance hostile takeovers. That led to abuses in Milken’s operation, which created a backlash ending in federal felony charges.
Even after it settled with the government, Drexel had a chance to survive if it could slim down. But Joseph lost control over his top dealmakers, who, to prove that the firm could flourish without Milken, went on a disastrous spree at precisely the wrong time. Because the bright and hardworking staff had been motivated almost solely by making a buck, esprit de corps degenerated rapidly into every man for himself once the money slowed. The firm floated issues for marginal companies and then flogged them furiously to customers. What couldn’t be sold—and this became fatal—had to be inventoried.
Although few participants are willing to speak on the record, the picture that emerges of Drexel‘s final days is of a firm thrashing desperately to avoid the inevitable. That was nowhere more evident than in the last-ditch efforts to raise cash. Although Joseph and his chief financial officer, Richard Wright, had been warned that a liquidity crisis would likely hit the firm, they failed to alert the directors and senior officers until a few days before the end. As the junk bond market was tanking in the U.S. last fall, Drexel Chairman John Shad, the former chairman of the Securities and Exchange Commission who had railed against junk bond takeovers, was in the Far East assisting Drexel‘s effort to raise money for the firm by selling junk that couldn’t be sold domestically. Even after the onset of the credit crisis, Wright continued urging Drexel‘s reluctant salesmen to peddle the firm’s own risky commercial paper.
Drexel‘s final throes obscure another story of how business really works when inexperienced outsiders try to wrest power from those who are used to having it. As Drexel‘s capital evaporated, its bank lenders quietly abandoned it. By February 1990, when regulators stepped in to stop Joseph from dissipating what capital remained, only the top officials at the Treasury Department and the Federal Reserve could have saved the firm. And they were not about to. Says a former Treasury official: “People down here said, ‘Hell, no. There’s no reason anybody should do anything. We don’t like ’em.'”
The story of Drexel‘s demise goes back to 1978, when Milken moved the high-yield bond department from New York to his hometown of Los Angeles. Milken’s father was dying of cancer, and Mike’s young children had health problems. Milken told his superiors that at least one of his kids was subject to epileptic seizures, and that he and his wife, Lori, wanted to be closer to their families on the West Coast.
The move paradoxically brought Milken closer to Fred Joseph, then head of the corporate finance department in New York, which had serious image problems. At the time the only Harvard business school graduates Joseph could recruit were those who had been turned down by other Wall Street firms. But the view of Drexel as an investment banking backwater began to change with Joseph’s discovery that Milken’s big junk buyers—companies like Rapid-American and Reliance Insurance—were also eager to be big junk issuers. They were the engine that propelled Drexel to fourth place among all underwriters by 1986 and enabled Joseph to hire attractive, personable bankers like Martin Siegel, who had made a name for himself in mergers and acquisitions at Kidder Peabody.
Milken and Joseph were a team from the beginning. Milken may have been the much-pampered genius with gleaming new offices in Beverly Hills, but Joseph was the smooth, articulate voice of the firm and the man who was building the institution around Milken. From their offices on opposite coasts, they spoke to each other five to 15 times a day.
One former Drexelite describes the West Coast office that Milken ran as “structurally antisocial,” entrepreneurship bordering on anarchy. Milken’s Hobbesian style of management may explain much of the corner-cutting that went on in Beverly Hills and caused so much trouble with the regulators. A former Drexel broker recalls hearing one of Milken’s salesmen threaten a client over the phone: “If you don’t buy these bonds from me, I’ll burn your house down!”
Back in New York it was easy to ignore Milken’s managerial weaknesses. Fees were rolling in like the waves at Malibu, and Joseph took his fair share of credit for them at the board meetings. Of every dollar the high-yield department made, close to two-thirds went to the firm, and the rest went to Milken and his group. Drexel‘s East Coast executives, many of them holdovers from the old Burnham & Co., the retail brokerage firm that had bought Drexel Firestone in 1973, had never seen such money.
An executive who joined Drexel in the mid-1970s recalls being shocked that a senior partner’s interest in the firm was then worth only about $400,000—a pittance even by the standards of the day. By the mid-1980s, he said, a partner with this much equity was worth about $15 million. Another former officer recalls hearing Robert Linton, then chairman, say that one of his great motivations was watching the book value of his stock go up every month.
When Joseph and Milken committed Drexel to the hostile tender offer financed by junk bonds, they enraged a powerful special-interest group—the CEOs of big corporations and their board members, lawyers, bankers, and political representatives. Drexel also made a dangerous enemy on Wall Street in Salomon Brothers, heretofore the top bond house and every bit as tough and sharp-elbowed as Drexel itself.
As early as 1984, Drexel was trying to monopolize the high-yield business. It refused to allocate any bonds on a deal it underwrote for Golden Nugget, the casino operator, to Salomon Brothers, which had customers for them. According to two eyewitnesses, Salomon’s chairman, John Gutfreund, was in such a frenzy over these tactics that he warned Joseph that he was going to get Milken. Gutfreund’s precise phrase, though his firm denies it, was “knee his nuts off.”
The more genteel but equally direct reaction of big business came in 1985 when Drexel financed T. Boone Pickens’s $8.1 billion raid on Unocal Corp., then the 12th-largest U.S. oil producer. Fred Hartley, who was Unocal’s forceful CEO, had plenty of Washington connections. His investment banker was Nicholas Brady, then head of Dillon Read, a former U.S. Senator from New Jersey, and a good friend of the Vice President, George Bush.
While Hartley worked the press, equating Drexel to a terrorist group, Brady and other Washington insiders got Congress on the warpath. Says a former White House official: “Nick really hung Drexel out to dry. He put the firm in Congress’s gunsights.”
More specifically, in the sights of then-Congressman (now Senator) Timothy Wirth of Colorado and New York Senator Alfonse D’Amato, who chaired hearings on the dangers of takeovers and junk financing. Fred Joseph was called to testify, as were such Drexel-financed raiders as Carl Icahn and Boone Pickens. Among the chorus of Cassandras prophesying the doom of financial markets if junk bond takeovers were not curbed was SEC Chairman Shad. Said he: “The more leveraged takeovers and buyouts today, the more bankruptcies tomorrow.” Unocal ultimately bought Pickens off, and Congress never acted on the 30 or so bills that came out of the hearings, but Drexel had been warned.
On November 14, 1986, Ivan Boesky, a longtime Milken client, pleaded guilty to SEC charges of insider-trading violations based on allegations made by investment banker Dennis Levine. Burnham & Co. founder I. W. “Tubby” Burnham, chairman emeritus, was the only board member to suggest that Drexel might throttle back on junk bonds. When Milken heard about Burnham’s radical idea, he threatened to quit. Fearing they would lose their Midas, board members put Burnham’s proposal to a vote and defeated it resoundingly.
Within two months of what became known as Boesky Day, Aetna Life & Casualty Co. notified Joseph that it would not renew Drexel‘s excess insurance protection, which guarantees replacement of securities in a customer’s account above the $500,000 covered by the Securities Investor Protection Corp. According to sources at Drexel, Joseph was told that Aetna’s decision not to renew had been made “at a very senior level” and was “not appealable.” Drexel had to self-insure, and that cost the firm about $11 million more than it paid Aetna.
Senior Drexel officials were convinced that Aetna’s blue-ribbon board of directors was behind the decision not to renew coverage. On the board were David Roderick, former chairman of USX, and Warren Anderson, former chairman of Union Carbide, both of whom had faced Drexel-financed raiders and been forced into painful restructurings. An Aetna spokesman says that the board was not involved in the decision but that, because of the Boesky scandal, it was made at a higher level of the company than normal.
The government began subpoenaing witnesses and preparing indictments against Drexel and Milken based on information it had obtained from Boesky. Throughout 1988 the competitive pressure on all Wall Street firms to do deals, even bad deals, was intense. Says one of Milken’s key West Coast lieutenants: “The government investigation spurred us on to prove that we were still the most powerful. That’s why the quality of the credits we underwrote began to fall off.”
Preoccupied with preparing a legal defense, Milken was giving the firm only 25% of his prior time and effort. He recognized that Drexel, like everyone on Wall Street, was doing deals on the dangerous assumption that companies could sell assets tomorrow for more than they were worth today, and therefore could afford staggering levels of debt. But he was as much of a deal junkie as anyone else.
When Joseph told the $100 million man of the crisis, he quit the board on the spot.
Drexel had been negotiating with the U.S. Attorney’s office and the SEC for almost two years, and government lawyers were furious that the firm had not yet done the decent thing—dump Milken and plead guilty. An impatient U.S. Attorney for the Southern District of New York, Rudolph Giuliani, encouraged his subordinates to threaten Drexel with a RICO (Racketeer Influenced and Corrupt Organizations) indictment if the firm did not settle.
RICO frightened Joseph, and with good reason. Under the statute, the government might be able to lodge a claim on Drexel‘s assets that would be senior to the claims of the firm’s banks. Joseph believed that could lead the lenders to pull their lines of credit if Drexel were indicted.
Shortly after Thanksgiving, Joseph told the other members of the “war committee,” a small group that had been set up to coordinate Drexel‘s resistance to the indictment, that he was thinking of settling. He also kept the 22 board members informed of his every move. The lone voice in opposition to settling belonged to John Kissick, 48, the strapping head of West Coast corporate finance. Hugely popular within the firm, Kissick argued that admitting to guilt would be a mistake on principle because the firm did not know if it was guilty. Kissick had been hired by Fred Joseph in 1975 to run the West Coast corporate finance department, where he worked closely with Milken. He was torn between supporting Joseph—the man who had been his mentor—and Milken, the man who was his friend.
Two of Drexel‘s other stars faced a similar dilemma. Peter Ackerman, 43, was Milken’s brilliant and aloof deputy who designed the packages of securities that the issuers offered. Leon Black, 38, was the head of mergers and acquisitions; he found the targets for Drexel‘s raiders. Both were busy helping Henry Kravis structure $9 billion in debt securities that Kohlberg Kravis Roberts would use to pay for the monumental RJR Nabisco buyout. Joseph had them pulled out of a meeting to discuss rumors that they might leave if Drexel sold out Milken. According to a senior officer, all Ackerman would say was “Let’s see how this plays out.” But neither man resigned.
Then the Giuliani team infuriated the Drexel board by demanding that the firm’s employees waive attorney-client privileges in any future investigations. That meant the employees could be prosecuted later on the basis of information they had given Drexel‘s lawyers who were preparing the firm’s defense. On December 19 the board voted overwhelmingly not to settle.
That night the corporate finance department held its Christmas party in the grand ballroom of the Waldorf-Astoria hotel. Board Chairman Robert Linton appeared onstage to sing “Rudy the Red-Nosed Reindeer,” with lyrics that made it clear Rudy was no reindeer and Drexel was remaining defiant. The crowd of about 800 people went wild, screaming and banging the tables. One skeptical senior investment banker recalls going over to Joseph, sticking his finger in Fred’s stomach, and saying, “I hope it’s not helium in there like the Macy’s Thanksgiving Day balloons.”
Joseph’s reply came two days later. He met with the board in the morning and announced that a settlement had been worked out. Giuliani backed off on the issue of attorney-client privilege, and Drexel agreed to plead guilty to six felony counts that included dealings with Ivan Boesky. The firm would also pay $650 million in penalties and cooperate fully with the government investigations of its employees and customers.
What apparently tipped Joseph toward settling was hearing a taped conversation of accusations against Milken made by a Drexel trader. This was the first time Joseph realized the government had more against Milken than just Boesky’s allegations. He was also shown some spread sheets on transactions that, combined with the tape, would lead knowledgeable people to the conclusion that Milken bent the rules too far. Joseph informed the board that Giuliani required an answer by four that afternoon, or he would hold a press conference announcing a RICO indictment.
After two years and hundreds of millions of dollars spent warring with the government, the decision came down to a board vote, and it wasn’t even close—16 to six in favor of settling. Kissick voted no, as did Joseph in a misguided symbolic protest that infuriated employees, who thought he was being hypocritical.
Especially demoralized were the employees on the West Coast, who thought they saw a sellout. Unsubstantiated rumors spread quickly in Beverly Hills that Joseph cut the deal in exchange for personal immunity from prosecution. Aware of the plunge in morale, Joseph moved quickly to hold his top producers in the high-yield department and corporate finance.
The firm seemed to have money to burn—$1.4 billion in capital, $1 billion more than required by regulations—and Joseph started spreading it around. He guaranteed key employees, although not in writing, that their 1989 compensation would equal at least 75% of 1988’s, which had been huge. But unlike the previous arrangement Drexel had had with the high-yield group when Milken was running it, the new package did not tie compensation to the profitability of the firm.
Joseph, according to a senior manager of the firm, had long thought that Bear Stearns & Co. had made a big mistake to let Henry Kravis get away rather than meet his demands for more money. Joseph was determined to keep Ackerman, Black, and Kissick, even at the risk of paying them so much that he became, in effect, their subordinate. In April 1989 he agreed to give Ackerman at least $100 million as a reward for his performance in 1988 and for helping sell the RJR Nabisco bonds in 1989. In addition, Ackerman and Black were told that the more deals they brought in, the higher their bonuses.
When rumors got out about the special arrangements Ackerman, Black, and a few others had negotiated, morale took another nose dive. A former member of the Drexel board jeers, “The key to success was being a pig.” To allow his other investment bankers to vent their anger and envy, Joseph brought in a psychologist named Ned Kennan, who is used by many companies, including KKR. What did employees tell Kennan? According to a former top investment banker, “That everybody hated Peter and Leon.”
Milken’s departure in 1989 forced Joseph to restructure the firm around Ackerman, Black, and Kissick: Black became one of the new heads of corporate finance, Kissick was given Milken’s old job as head of the high-yield department, and Ackerman was named head of a new capital markets group.
The settlement also brought John Shad, 66, out of retirement. The SEC insisted that Joseph find a Mr. Clean to install as chairman of the board of the holding company. Howard Baker, former White House chief of staff and Senate majority leader, had turned Drexel down because Joseph would not yield the CEO’s title. But Shad, who had been Joseph’s former boss in the early 1970s when they were both at E.F. Hutton, consulted with his old friends Nicholas Brady, now Secretary of the Treasury, and Alan Greenspan, chairman of the Federal Reserve, and took the job. Shad’s $3.1 million salary went into a trust set up for the Harvard business school, to which he had pledged $20 million for the study of leadership and ethics.
THE BAD DEALS
Black, Ackerman, and their colleagues were determined to prove that Drexel could still do deals better than any other firm. In the first half of 1989, its market share actually increased to 70%, vs. 40% for the first half of 1988. But much of that came from the two big bond offerings that Drexel managed for the RJR Nabisco buyout. And now doing deals was putting the investment bankers themselves increasingly at risk. Like everyone else on Wall Street, Drexel had to compete by putting up its own money as a bridge loan. In the past Milken’s network of ready buyers made this practice unnecessary.
Kissick tried hard to stop questionable deals but lacked the needed clout. As an investment banker, he knew little about selling and trading junk bonds and was still broken up over the firm’s shabby treatment of Milken.
Among Drexel‘s worst-selling underwritings of 1989 were those that Leon Black did to help William Farley, the T-shirt titan, take over textile maker West Point-Pepperell. Farley needed over $1 billion to swing the acquisition, and Kissick questioned whether such a deal could be sold. But Black did not want to see Drexel welsh on its promise to raise the money for Farley, so he and Ackerman bulled it through. Unfortunately for the firm, Kissick’s concerns were verified by the market when Drexel failed to sell $250 million of the paper and had to inventory the stuff.
Ackerman also had his fair share of fiascos. Drexel raised about $140 million to refinance the purchase of one of his clients, Edgcomb Metals, a Tulsa steel wholesaler, by the Blackstone Group, a Wall Street buyout boutique. Six weeks after the deal closed, the company’s business deteriorated and over half the bonds were still in Drexel‘s inventory.
A wrinkle in the refinancing suggests that the motivation behind it was not simply helping a client. Ackerman profited personally. He owned part of Edgcomb through a private partnership, and according to an informed Drexel executive received $6 million to $7 million when the company was sold. A Drexel spokesman disputes this figure as being “way off.” But a senior West Coast manager says Drexel sometimes did deals in order to “cash out” its officers’ positions.
Unsold private placements and bridge loans Drexel made to clients began piling up in the holding company’s inventory. Like many brokerage firms, Drexel was set up as a holding company with a broker-dealer subsidiary; while the broker-dealer was regulated by the SEC, the holding company was not unless it held publicly traded securities. The SEC requires that broker-dealers mark their inventories to market; and as the public junk market slid, the broker-dealer inventory showed losses. But Drexel did not have to mark to market the private debt and bridge loans that were in the holding company’s hands, and could maintain the fiction that they were worth their paper values.
By the third quarter of 1989, Drexel‘s holding company was stuck with an estimated $1 billion of private junk bonds and bridge loans. These represented capital commitments the firm had made to customers, and Drexel had to borrow the money to carry them and to remain in business. Says an ex-Drexel officer: “Our bridges had turned into piers.”
Meanwhile junk bond offerings that Drexel had already sold were coming apart. Some, like the bonds of Integrated Resources, the issuer most closely associated with Drexel, were old deals. Integrated was a financial services company that sold real estate tax shelters until the 1986 Tax Reform Act eliminated most write-offs for limited partnerships and cut the heart out of its business. By June 1989 it was unable to roll over its commercial paper, but Drexel did not step up to become the buyer of last resort as the market expected. Says a formerDrexel salesman: “When we let Integrated go down, the buyers lost all confidence.”
But most of the deals that singed customers were of more recent vintage. One that resulted in third-degree burns was Memorex, the maker of magnetic computer tape, for which Ackerman raised $555 million last July. Two months after the offering, the company reported a 66% decline in operating income, and the bonds plunged from par to 50 cents on the dollar. It turned out that foreign investors had the right to sell their Memorex bonds back to Drexel at par. When some did so, the firm booked an estimated $30 million loss. Drexel did not step in to support the market for its other customers, however.
The impact of Drexel‘s refusal to support Integrated and Memorex cannot be overemphasized. The firm had finally killed its famed network of buyers.
That summer Congress passed the savings and loan bailout bill, which required thrifts that owned junk bonds to sell them by 1994. The S&Ls promptly stampeded out of junk, and the secondary market began to slide.
Issuers were beginning to default on a weekly basis. Many of the exploding deals were not Drexel‘s, but the firm suffered the consequences more than anyone else because it depended so heavily on the business. Fees from new underwritings dropped, and trading in the secondary market became markedly less profitable. In August and September the firm began losing money. In October the losses hit $86 million.
By late summer Ackerman, who has a Ph.D. in political science from the Fletcher School of Law and Diplomacy near Boston, was telling Joseph that he wanted to move to London to write a follow-up to his doctoral dissertation on the strategy of nonviolent resistance. To hang on to Ackerman, Joseph created a position for him in London developing overseas business for the firm. This sojourn by one of the biggest producers puzzled many at the firm, but not a friend of Ackerman’s, who says, “Peter wanted to get as far away as he could.”
As Drexel‘s situation deteriorated, Joseph became more withdrawn. According to a longtime Drexel executive, “Fred sort of blew his cork and became a different human being the lastyear.” Meanwhile Chairman John Shad and an entourage spent a good part of the fall in the Far East trying to sell junk bonds. Shad says he talked only about general market conditions in high-yield bonds and leveraged buyouts. But Drexel‘s former Hong Kong managing director Marc Faber says: “I took him to see Jardine Matheson, a conservative, blue-chip company. Shad asked the treasurer, ‘Do you have any high-yield bonds in your portfolio?’ The treasurer said, ‘Of course not.’ These were investors in quality. Shad was crazy to try to sell junk to these people.”
More ominously, Drexel‘s lenders were losing their nerve. Hit with bad loans to real estate developers, many began to back away from Drexel. That was a nightmare for Joseph and Richard Wright, the chief financial officer, because without bank loans, Drexel didn’t have enough capital to finance its inventory and run its business. The banks were offered the inventory of private placements and bridge loans as collateral for the lines but said it wasn’t good enough. Wright’s staff began to warn him that the high-yield position had to be reduced and that Drexel was on borrowed time.
Wright did not pass the dire message along to the board. Why not? Says one of his former subordinates: “It was difficult to tell whether he didn’t believe the warning or whether he felt his timing was wrong.”
In November, Standard & Poor’s lowered its rating on the holding company’s commercial paper from A2 to A3. Overnight Drexel was shut out of the commercial paper market, the source of $700 million of financing. Within three weeks, as holders refused to buy Drexel‘s paper when it came due, it was reduced to only $300 million of borrowings.
Desperate, Wright flew to Paris to ask Groupe Bruxelles Lambert, the French and Belgian investors who were Drexel‘s largest shareholders, for more money. Their reply: Non, merci. They wanted to see a return to profitability first. Wright took ill in Paris and was hospitalized, reportedly with an ulcer.
As the new year approached, Joseph and Shad, the head of the compensation committee, made final decisions on the bonus pool. While knowing that the firm might lose money for the year, they set the payout at a healthy $270 million, vs. $506 million in 1988, but decided that 24% of that pool would be given in Drexel stock.
When the bonuses were announced in December, Leon Black was perturbed at how small his was, a mere $12 million. According to several Drexel officers, Black went home and sulked for a couple of days before Joseph relented and gave him $3 million more. Joseph, as if to compensate the firm for the cash drain, took his $2.5 million bonus entirely in Drexelstock.
Meanwhile, Drexel‘s financial plight was worsening. Throughout the year the firm had borrowed $650 million from its commodities trading unit. The commodities group usually borrowed gold from foreign central banks, then sold the gold and lent the cash to the holding company. But in December, when Drexel was unable to roll over more commercial paper, it could no longer pay back its commodities unit on demand.
The new year began badly. After months of erosion, the junk bond market collapsed as jittery holders began dumping en masse. In January, Drexel lost $60 million.
As more and more banks refused to extend the lines of credit backing up Drexel‘s commercial paper, the money from the firm’s commodities trading unit no longer sufficed to finance the holding company’s inventory. Wright, with the approval of Fred Joseph, began to raid the broker-dealer, which still had capital in excess of the regulatory minimum, and Drexel‘s government-securities dealer. In late January he drained these two units of about $400 million, despite warnings from his staff that the firm would run out of capital within 30 days. He told a member of his group, “Well, maybe the salesmen can sell more commercial paper.”
Neither Wright nor Joseph informed the board of directors about Drexel‘s precarious state. Nor did they report to the New York Stock Exchange or the SEC—which both require that brokers have a certain amount of capital to meet their obligations—that they were taking money out of the broker-dealer. But on February 2, the New York Fed got wind of the transfers and passed the word to the SEC and the exchange regulators, who were aghast. Drexel firmly believed that its longtime nemesis, Salomon Brothers, tipped off the Fed, but Salomon denies the charge.
From this point on, the regulators called the shots. On Thursday, February 8, the stock exchange officials, after consultations with SEC Chairman Richard Breeden, telephoned Wright and told him that he could not take more money from the broker-dealer without SEC approval. Wright relayed the bad news to Joseph, who was at his farm in rural New Jersey.
A meeting of the department heads who ran the firm was hastily convened, and Joseph was hooked in by phone. Wright explained that $400 million in unsecured debt was coming due within the next two weeks, with another $330 million scheduled to mature in March. Then the senior officers heard the head of the commodities trading unit explain his Rube Goldberg borrowing arrangement with the foreign central banks. And by the way, he told his dumbfounded peers, he needed his $650 million back, pronto, to repay the loans. According to a department head, recriminations began to fly about who knew what—and when—about the firm’s financial condition.
On Friday, February 9, Wright was feeling the pressure. According to former Drexel officers, in the morning he and his treasurer were urging Drexel‘s commercial paper salesmen to sell more paper, despite widespread fears that the firm was on the edge of bankruptcy. Incredibly enough, the salesmen were able to flog millions of dollars’ worth only two days beforeDrexel went belly-up.
In the afternoon the department heads reconvened to consider the options. About a year too late, Joseph proposed a draconian plan to save the firm: Cut costs, sell inventories of stocks and high-grade bonds, pull out of the commodities and mortgage-backed securities business, and sell off the junk holdings. Everyone was working around the clock that weekend. But when Joseph, telephoned Peter Ackerman to tell him of the liquidity crisis, Ackerman resigned from the board on the spot.
Saturday was spent trying to sell operations to free up capital. But says a board member: “You don’t get out of businesses in a day or a week. They were either blind and dumb or in some dream world.” By Saturday night a frantic search was on for a merger partner. Desperate senior officers began calling their Wall Street competitors, saying in effect, “How about sending in a team to take a look tomorrow?” A few browsed, including Smith Barney and Nomura, but no one bought.
On Monday morning rumors of Drexel‘s imminent bankruptcy were sweeping the world’s bourses. Says a former Drexel floor broker: “When I walked out onto the floor of the [New York Stock] exchange, I could sense that something was the matter. Stories were flying that we were already out of business.”
They were—almost. Drexel‘s only hope of salvation was its banks, which had been hounding various members of the firm for days trying to find out whether rumors of bankruptcy were true. Joseph spent the day readying a $1.1 billion bundle of securities that the banks might accept as collateral for a $300 million to $400 million loan. These securities were the same old bridge loans and private placements that Drexel hadn’t been able to sell before, plus the right to income from a portfolio of leases. After giving the securities a haircut for their illiquidity, Joseph and the bankruptcy experts he had called in over the weekend put the package’s worth at $800 million.
At dusk on Monday, February 12, a bevy of bankers in pin stripes, armed with calculators, marched into a seventh-floor conference room at Drexel Burnham’s headquarters. Joseph knew he was not adequately prepared for the meeting and that the bankers would have serious questions about the quality of the merchandise he was offering as collateral. But he thought there was a better than even chance they would lend Drexel the money anyway. After all, he was sure that the regulators were urging the banks to help out. In fact, he figured the federal government, with a wink and a nod, had already lobbied the lenders to make the loan rather than let Drexel fail. Isn’t that the way these things are done?
For their part, the bankers were angry that Drexel hadn’t come clean earlier. Joseph announced to the not altogether surprised group that Drexel had a liquidity problem and needed to borrow $300 million to $400 million. According to a banker at the meeting, he said the foreign central banks that had been funding Drexel were unwilling to continue that arrangement, but that certainly Drexel‘s loyal commercial lenders had more courage. Then the bankers received a list of the collateral and recognized it as the same junk they had disdained earlier. They were being asked to take a credit they had already passed on.
Fred Joseph then sealed Drexel‘s fate. He said in response to a banker’s query that the firm had missed a scheduled repayment earlier in the day to holders of some commercial paper. Says a banker who was in the room: “So the situation was already worse than we had thought before the meeting. Drexel was in danger of cross-defaulting on all its loans.”
The bankers went through the motions of caucusing. After a few minutes they told Joseph that they could not make a decision that night and that they were not inclined to make the loan anyway. Joseph implored them to call their headquarters and seek approval. The bankers dutifully telephoned. The answer? Forget it.
They huddled again. Sentiment had hardened, but Joseph was not going to give up. He pleaded for the home phone numbers of the banks’ top officers so that he could make personal appeals. Joseph’s calls took them away from their dinner tables and televisions. But to no effect. There had been no regulatory winks and nods. By 12:30 A.M., Joseph let his exhausted troops drift home.
He, however, had one more humiliation to undergo. At 1:30 A.M. he telephoned the SEC’s Richard Breeden and Gerald Corrigan of the New York Federal Reserve, who were at their homes, and informed them—as if they did not already know—that the banks had turned Drexel down. Breeden and Corrigan said that they were speaking for their respective bosses, Treasury Secretary Nicholas Brady and Fed Chairman Alan Greenspan. They suggested that Drexel file for Chapter 11 the next day or face government liquidation. It was only then that Joseph realized his firm was history. As he said to a colleague, “God has spoken.”