I had the opportunity recently to catch up with legendary billionaire financier Michael Milken. For me, this was an opportunity to see my investing mentor, since I have spent most of my investment career in distressed securities.
Starting in 1969, Milken’s central investment thesis has been that many AAA rated bonds would have a higher default rate than single B industrials. As an example, he would cite that AA rated railroads defaulted at a higher rate than B rated industrials from 1900 to 1970.
His at-the-time radical investment theories essentially created the $600 billion junk bond market that we have today. This innovative financing helped spawn new companies and develop entire industries, like Kindercare, the first chain of day care centers, MCI, the first low cost telecommunications carrier, and Turner Broadcasting (CNN).
In light of the current turmoil in the AAA-rated credit markets, Mike’s theories look particularly prescient. Despite all the hysteria and hand wringing in bondland, the rating agency Moody’s has announced that there have only been 17 announced defaults this year, compared with 26 for the year 2006.
During his speech, I learned for the first time why Mike Milken started out as a math/science major at the University of California at Berkeley and then switched to study business. Surprisingly, it was due to the civil rights movement.
“I came to realize that civil rights meant more than where you could sit on a bus, or eat lunch, or attend school. It also encompassed the chance to start a business and succeed or fail on your own merit. So I changed my major to business and began studying ways to increase access to financial capital for people and companies that had traditionally been excluded from the capital markets.”
Milken’s thoughts on economic freedom should not be ignored in the Israel-Palestinian peace process. Unfortunately, economic prosperity for the Palestinians is only one piece of the puzzle.
When Milken started his career on Wall Street in 1969, access to capital for growing businesses was limited. Financial technology, which included securitization, derivatives, and a liquid bond market, is an important component of prosperity. Milken was one of the first to democratize capital.
He explained, “In the course of my work at Berkeley, and later at Wharton, I developed a formula to explain the components of prosperity. The formula,
P=Fti*(HCi+SCi+RAi) says that prosperity in any society equals the effect of financial technologies acting as a multiplier on the total value of human capital, social capital, and the real assets that are typically found on balance sheets.”
Nobel Prize Winner Gary Becker defined human capital as “the knowledge, skills and experience of people.” Milken stated, “In my own career, it has been the most-important factor in determining which entrepreneurs to finance.”
Milken pointed out that we do not still quantify human capital on the balance sheet. Where is the value of Steve Jobs on the Apple balance sheet? Just before Jobs's comeback, Sony's market capitalization was 15 times that of Apple. Now Apple is worth 3 times Sony, mostly thanks to Steve Jobs.
There is an economic movement now brewing to attach economic value to human capital and place it on the financial statements of a company.
Mike continued, “An example of how human capital relates to economic growth can be seen in a comparison of two former British colonies, Jamaica and Singapore, both small islands with sub-tropical climates. As recently as the early 1960s, the per-capita GDP of these two areas was virtually identical, at about US$1,900 (in 2007 dollars). Then they chose different economic paths: Jamaica focused on agriculture, mining and tourism; Singapore invested in its human capital and established an Economic Development Board to lead its industrialization. By 2007, Singapore’s per-capita GDP had grown to about US$32,000. Jamaica remains a relatively underdeveloped economy with 2007 per-capita GDP under US$4,000 (8 times smaller).
The day after the speech, the Milken Institute held a financial innovations lab to find new ways to finance more scientific research in Israel. There is also an effort underway to bring back Israeli scientists who have gone abroad because of the greater availability of funds for research outside Israel. Milken in his speech and Dan Dankner of Bank Hapoalim (at the Globes Israel Business Conference) both hold up the example of Singapore as a good one for Israel to emulate.
Although Mike refused to speak to reporters, I was able to glean from his associates some acorns of sage investment advice that I can pass on to you. I had always wondered why Milken preferred bonds over stocks. Nick Mitsakos, now a private investor in San Francisco, said, “When I asked Mike why he preferred bonds over stocks, he told me that you could be right about a company but still not make money on the stock because of the market. With a bond, you will always make money if you were right about the company.”
Michael Milken did not let obstacles stand in the way of a good investment. Nick said, “When I brought him a good investment except for the tax obligations, he did not say no to the investment. He told me, a 26 year old junior employee, to go and change the tax law. “
Even when stricken with prostate cancer, Milken did not let obstacles stand in his way. And since the 1980s, he has turned his razor sharp intelligence to revolutionizing health care. If anyone can cure cancer and heart disease, he can.
In the interests of balanced reporting, my editors insisted that I mention Milken’s 1990 conviction for violating securities laws. But the conviction is not the whole story. "The New York Times" wrote this week about Milken’s prosecutor and now presidential candidate, Rudi Giuliani, “His pursuit of a political career while commanding the prosecutor’s stage stirred deep unease."
In "The Wall Street Journal" (July 18, 1995), Jonathan Macey, currently a Yale law professor, described the prosecution of Mike Milken as “the vengeful response by American’s business and regulatory establishment to Mr. Milken’s phenomenal success.” He compared Mr. Giuliani’s prosecution of Milken to another black period in American history - Joseph McCarthy's persecution of supposed Communists.
The world would have been a different and a better place if Milken had been allowed to innovate. Milken’s continued and further involvement in the State of Israel can only help us. In my next column, I will write about the financial innovations lab conducted by the Milken Institute.
Laura Goldman worked on Wall Street for over twenty years for such firms as Merrill Lynch and UBS Warburg. She now runs her own investment advisory, LSG capital, from Tel Aviv. She is an independent commentator, and her views do not necessarily represent those of "Globes".
Published by Globes [online], Israel business news - www.globes.co.il - on December 17, 2007
© Copyright of Globes Publisher Itonut (1983) Ltd. 2007