Creature From Jekyll Island by G. Edward

Deception itself doesn't constitute illegal fraud when it'sauthorized by an accounting system such as the Generally AcceptedAccounting Principles (GAAP) system which allows institutions toforego recording assets at their true worth, maintaining them insteadat their inflated value. The regulatory accounting principles system in1982 added even new options to overstate capital.... Intensespeculation, such as we observed in these firms, is not necessarily badmanagement at all. In most of these cases, it was clever management.

There were clever gambles that exploited, not depositors or savers, buttaxpayers.1

The press has greatly exaggerated the role of illegal fraud in these matters with much time spent excoriating the likes of Donald Dixon at Vernon S&L and Charles Keating at Lincoln Savings.

True, these flops cost the taxpayer well over $3 billion dollars, but all the illegal fraud put together amounts to only about one-half of one per cent of the total losses so far.2 Focusing on that minuscule component serves only to distract from the fact that the real problem is government regulation itself.

JUNK BONDS ARE NOT JUNK

Another part of the distraction has been to make it appear that the thrifts got into trouble because they were heavily invested in

"junk bonds."

Wait a minute! What are junk bonds, anyway? This may come as a surprise, but those held by the S&Ls were anything but junk. In fact, in terms of risk-return ratios, most of them were superior-grade investments to bonds from the Fortune-500 companies-1. "FIRREA: Financial Malpractice," by Edward J. Kane, Durell Journal of Money and Banking,

May, 1990, p. 5.

2. "Banking on Government," by Jane H. Ingraham, The New American, August 24, 1992, p. 24.

HOME, SWEET LOAN

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So-called junk bonds are merely those that are offered by smaller c o m p a n i e s which are not large enough to be counted among the nation's giants. The large reinvestors, such as managers of mutual funds and retirement funds, prefer to stay with well-known names like General Motors and IBM. They need to invest truly huge blocks of money every day, and the smaller companies just don't have

enough to offer to satisfy their needs. Consequently, many stocks and bonds from smaller companies are not traded in the New York Stock Exchange. They are traded in smaller exchanges or directly between brokers in what is called "over the counter."

Because they do not have the advantage of being traded in the larger markets, they have to pay a higher interest rate to attract investors, and for that reason, they are commonly called high-yield bonds.

Bonds offered by these companies are derided by some brokers as not being "investment grade," yet, many of them are excellent performers. In fact, they have become an important part of the American economy because they are the backbone of new industry.

The most successful companies of the future will be found among their ranks. During the last decade, while the Fortune-500 companies were shrinking and eliminating 3.6 million jobs, this segment of new industry has been growing and has created 18 million new jobs.

Not all new companies are good investments—the same is true of older companies—but the small-company sector generally provides more jobs, has greater profit margins, and pays more dividends than the so-called "investment-grade" companies. From 1981 to 1991, the average return on ten-year Treasury bills was 10.4

per cent; the Dow Jones Industrial Average was 12.9 per cent; and the average return on so-called junk bonds was 14.1 per cent.

Because of this higher yield, they attracted more than $180 billion from savvy investors, some of whom were S&Ls. It was basically a new market which was orchestrated by an upstart, Michael Milken, at the California-based Drexel Burnham Lambert brokerage house.

CAPITAL GROWTH WITHOUT BANK LOANS OR

INFLATION

One of the major concerns at Jekyll Island in 1910 was the trend to obtain business-growth capital from sources other than bank loans. Here, seventy years later, the same trend was developing

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80 THE CREATURE FROM JEKYLL ISLAND