Michael Milken to Potentially Lower School Test Scores
Michael Milken earned the moniker as "The Junk Bond King" in the 1980s when he pioneered and essentially created the market for high-yield bonds. The company he worked for is no longer around. Most of the companies bonds were issued for are no longer around. Milken is now involved in philanthropy yet there is a direct connection between junk bonds and public school testing scores.
The connection begins in 1987 just prior to the stock market collapse in October. A few years prior Milken had essentially created a new trading market for high-yield bonds. High Yield Bond were a means for less financially stable companies to raise a great deal of cash by borrowing against their potential rather than actual revenues. The bond market rated and still rates bonds based on the financial stability and solvency of the companies issuing them. Prior to Milken "risky" companies could not raise capital because no one wanted to be burdened with their debt should the companies fail. Milken enticed the purchase of these bonds by increasing their yield (the money they paid out) to a level that the risk/reward calculations finally made investor sense. Investors were willing to take the risk and buy these bonds because their yields made for potentially huge profits.
Milken and the investment bank he worked for (Drexel Burnham Lambert, Inc.) began selling these H-Y bonds, or "junk bonds" for a whole range of companies and financial institutions. While highly complex there was a brilliance to this financial market. DBL would raise huge amounts of capital for these risky clients, who could then use this capital to expand or buy more financially stable companies which would then provide the revenue to pay off the debts from the bond sales. DBL found a large pool of clients from within the savings and loan industry. One of their clients was a struggling savings bank called Imperial Savings and Loan. The problem with Imperial, and all the savings and loans, was that no matter how much money they raised and put into mortgages they were never going to reach the levels needed for bond risk/reward calculations to work out. They needed a way to leverage their income to allow for a huge increase in mortgage lending capability. Drexel's solution was to package up the mortgages and sell them off in a new financial instrument called a Collateralized debt obligation or CDO. What CDO's allowed Imperial to do is to write mortgages then sell off those mortgages as CDOs. They could then take the money earned from these sales to write even more mortgages and grow a tremendous pace.
As we saw, the only flaw in this system was the housing market (and unscrupulous/criminal bankers). When the housing market turned downward the mortgages became a burden and foreclosures rose. This stopped the sale of CDOs and the savings and loans like Imperial were left with huge debts and no way of bringing in revenues to cover them. Imperial collapsed along with the entire S&L industry.
The Collateralized debt or "packaged debt" market would remain out of favor until 1999. In 1999 a series of laws allowed financial institutions to expand out into other industries such as insurance, commercial and investment banking. CDOs once again became an instrument for leveraging income. By 2001 a complex pricing model was established and CDOs grew rapidly in popularity; so rapidly that the traditional mortgage market had more revenue than mortgage buyers. The solution to this dilemma was a repeat of the high-yield bond market, only this time for mortgage buyers. Mortgage banks could begin writing riskier loans, packaging these loans, and selling them off in order to write even more loans. As the number of mortgages written skyrocketed the CDOs became ever more complex; so complex that is estimated that most of the companies and organizations buying them didn't know what they were buying.
What CDO purchases were actually buying were a lot of risky loans packaged together. However; as long as the money kept coming into the mortgage market it didn't seem to matter what the status of the borrows was. If they were willing to sign the mortgage papers these banks were willing to put them into a new house. This was the meat and potatoes of the "sub-prime mortgage market;" selling mortgages to people whose credit did not warrant standard loan rates.
This, of course, caused the housing market to boom as well. With so much money available for mortgages property values skyrocketed, doubling and sometimes tripling. One of the primary beneficiaries of these skyrocketing property values were state and local governments. A huge percentage of public school funding is derived from property taxes. As the property values rose, so did their tax revenue.
Like 1987, the major flaw in the system is property value. Just a plateau; not even a decline, would put a strain on these sub-prime borrowers. A few defaults here, a few default there and soon risk for CDOs was greater than the reward. As the CDO market dried up, so did the mortgage lending revenue. This lead in turn to the beginning of the 2007/2008 foreclosure explosion which is sending property values tumbling.
Thanks to much of the property tax reform legislation (pioneered in California with Proposition 13), home buyers are able to have their home values readjusted downward. Property tax revenues around the nation are declining, sometimes rapidly. All the so called "under-funded public schools" will be more so. If there is any relationship between school funding and test scores it is very likely that scores will decline in coming years. Ironically, Drexel Burnham Lambert, which had invented CDOs were forced to sell most of their business to the investment firm Smith Barney. Smith Barney would be acquired by Primerica. Together with Shearson Lehman Brothers and Travelers Insurance, they would all be packaged together with Citibank to form Citigroup, Inc. This is the same Citigroup that is awash in bad loans and devalued CDOs, struggling not to meet the same fate as Bear Stearns.
|
|
