Drexel Burnham Lambert

~ the last words ~

I. W. Burnham II opened Burnham and Company in 1935 with $100,000, of which $96,000 was borrowed from his grandfather, a Louisville distiller. It was a small house that did well and stayed small, and by the early 1970s Burnham wanted a name with enough standing to get his firm into the top tier of bond underwriting syndicates. Drexel Firestone had that name, tracing back to a Philadelphia bank founded in 1838, and had almost nothing else left. The two merged in 1973 as Drexel Burnham, and a 1976 deal with William D. Witter brought in the Belgian holding company Lambert Brussels and the final version of the name.

The thing that made the firm was already inside it. Michael Milken had joined Drexel Firestone in 1970 out of Wharton with a thesis about low-rated corporate bonds, specifically that the market priced their default risk far above what the historical record justified. He started by trading fallen angels, companies whose debt had been downgraded after issue, and then did something nobody had tried at scale: he underwrote new bonds for companies that had never been investment grade in the first place. That gave mid-sized firms and, later, hostile bidders access to money that had previously been reserved for blue chips. By the middle of the 1980s the high yield market was worth around $200 billion and Drexel was most of it.

1986 was the peak and the turn in the same year. The firm reported $545.5 million of net income on $4.8 billion of revenue with roughly ten thousand employees, the most profitable investment bank in the country. On 12 May a managing director named Dennis Levine was charged with insider trading. Levine gave the government Ivan Boesky, and Boesky gave the government Drexel. The SEC opened its investigation on 17 November 1986 and sued in September 1988. Everything after that is a wind-down with dates on it.

~ the record ~

~ the beverly hills desk ~

Milken moved his operation to Beverly Hills in 1978, which put the firm's entire profit engine three thousand miles from its own management. The desk started at four thirty in the morning to match New York, and the annual high yield conference it ran there became known as the Predators' Ball, because by the mid 1980s the people in the room included every corporate raider in America and the man who could raise them a billion dollars by lunchtime.

He was paid $550 million in 1987, which was more than the firm's entire net income in several of its good years and is still one of the largest single-year compensation figures ever recorded for an employee. That arrangement is the part that explains the collapse better than the fraud does. The people running Drexel in New York were not in a position to tell the Beverly Hills office anything, because without the Beverly Hills office there was no Drexel.

~ the plea ~

On 21 December 1988 the firm entered an Alford plea to six felony counts and agreed to pay $650 million, the largest penalty ever imposed under American securities law at that point. The leverage behind it was RICO: prosecutors had told the firm they would charge it under the racketeering statute, which would have required it to post a performance bond against forfeiture and would have finished it in days. Milken was indicted on 98 counts in March 1989 and left the firm. He pleaded guilty to six of them and was sentenced to ten years in November 1990. He served twenty two months and was pardoned on 18 February 2020.

~ the weekend the paper came due ~

A securities firm of that size funds itself on short term borrowing that it repays by borrowing again the next morning. By 1989 about 96 percent of Drexel's capital was other people's money on those terms, which works exactly as long as the lenders keep showing up. After the plea and the indictment they stopped showing up. The firm posted a $40 million operating loss in 1989, its first in fifty four years. In April it cut five thousand jobs and shut the retail brokerage.

On Friday 9 February 1990 the parent company had roughly $300 million of commercial paper maturing the following Monday and did not have the cash to repay it. It asked the Federal Reserve and the Treasury for help and was refused, and was told by the SEC that the choice was a voluntary filing or a seizure. The board voted on the evening of 12 February. The Chapter 11 petition was filed on 13 February 1990, after the firm had already defaulted on more than $100 million of short term loans.

Five thousand people lost their jobs in the weeks that followed, most of them with deferred compensation locked inside the estate. The reorganized shell emerged in 1992 as New Street Capital with twenty employees and a mandate to sell what was left of the book. The firm had carried about ten thousand people three years earlier.

~ what it left on the street ~

The alumni went on to build a good part of modern private credit. Leon Black left in 1990 and started Apollo, which bought distressed debt including a great deal of paper Drexel itself had underwritten, and Tony Ressler went from the same office to co-found Ares. The instrument survived its inventor's disgrace completely: high yield issuance is now an ordinary part of corporate finance and nobody calls it junk in a prospectus. What died on 13 February 1990 was a firm that had made itself indispensable to one market and had nothing else to stand on when that market decided to wait and see.

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