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The Milken Pardon and the Trump Connection?

posted by Adam Levitin

There's something really surreal about Donald Trump's pardon of Michael Milken. Trump and Milken were (with Ivan Boesky) the leading symbols of the excesses of capitalism in the 1980s. And here we are today. 

It seems that whatever Trump does, there's always a previous Trump tweet or quotation, and this time doesn't disappoint. Here's what a certain Donald J. Trump was quoted in 1990 in the NY Times regarding Milken's jail sentence:

"It's a very tough sentence. When you see that muggers and murders don't get as hard a sentence, it seems very tough. It may serve as a deterrent. If it does, then it will be a wise sentence."

In fairness to Trump, it's hard to see Milken's prosecution as having served as a much of a deterrent. But then, Milken went to jail for the wrong thing. He ended up pleading guilty to some (relatively minor) securities law infractions involving inaccurate securities filings in a case brought by the US Attorney Rudolf Guiliani (!). Milken was never prosecuted for his much more serious and complicated wrong-doing.

Milken appears to have been running a massive trading daisy chain that made junk bonds look far more liquid and better performing than they actually were. To the extent that junk bonds appeared to be a more viable investment class than they were, it benefitted Milken tremendously, because he made the market at his legendary X-shaped trading desk. A bigger market benefitted him more than anyone. 

The FDIC under William Seidman was hot on Milken's heels about this daisy-chain (in which a number of insolvent S&Ls were involved as buyers and sellers) when Milken pleaded guilty. The FDIC ended up with a civil settlement, but the criminal prosecution really ought to have been on the FDIC's theory. The result is that we never really got the full truth about exactly what Milken was up to. And although Milken paid a hefty fine, he also kept a heckuva lot of money. (Full disclosure: I benefitted indirectly from his largess in a job I had during graduate school.) 

I ended up digging into this history a bit several years back when researching the history of the collateralized debt obligation (CDO), which turns out to have its origins in a Milken deal. Milken had total control over the trading portfolio of Executive Life, a large California life insurance company. Executive Life had one of the largest holdings of junk bonds in the world. In order to make Executive Life's books look better to its regulators, Milken contrived to have Executive Life securitize a set of junk bonds. The securitization (the CDO) produced both some higher grade securities and some crappier crap. But because the regulatory treatment was binary—crap or not crap—it didn't matter how crappy the crap was. At least until the regulator wised up and forced Executive Life to unwind the deal as it was collapsing. So we have Michael Milken indirectly to blame for the 2008 financial crisis. As the late Lynn Stout remarked to me after hearing this tale, "Milken was the financial patient zero." 

Now of course there's a Donald Trump angle to all this. In 1990, Executive Life sued Milken's firm, Drexel Burnham Lambert, Merv Griffin, and Donald Trump for allegedly engaging in a scheme to inflate the value of some junk bonds related to a hotel property. All I've seen is a news story about the suit; the pleadings could be quite interesting, but the very fact of the suit suggests that Trump is not entirely arm's length from Milken. 

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