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Liar’s Poker
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Chapter 10 - EpilogueChapter Summaries & Analyses
Chapter 10 Summary: “How Can We Make You Happier?”
In 1985 junk bond king Michael Milken of Drexel Burnham visits John Gutfreund at Salomon, but they argue, and Milken is escorted from the building. By 1987 there is much bad blood between the men, and Milken backs corporate raider Ron Perelman in a bid for partial ownership of Salomon. Drexel is Salomon’s biggest competitor in the bond market, lately more profitable even than Salomon, and the only firm that makes Gutfreund nervous. Many Salomon traders defect to Drexel, where they earn much more: “Milken drowned his people in money” (259). He will lavishly reward a successful trader, then ask, “‘How can we make you happier?’” (259).
Lewis and Dash agree that a takeover isn’t a bad idea because “[o]ur management deserved the ax” (260). Salomon’s leaders have vastly overbuilt their offices in New York and London, then dismantled their most profitable department, mortgage bonds. The resulting losses pile into the hundreds of millions of dollars. Even worse, Salomon has failed to take advantage of Milken’s great new invention, junk bonds.
Corporations like to borrow money through bonds because the interest is tax deductible. Junk bonds are corporate bonds with ratings so low they won’t be touched by traditional investors. But Milken realizes that “fallen angels, the bonds of onetime blue-chip corporations now in trouble” are vastly underpriced: “The owner of a portfolio of fallen angels, by Milken’s analysis, almost always outperformed the owner of a portfolio of blue-chip bonds” (263). He sees that the standard credit rating system is inaccurate: “It focused on the past when it should have focused on the future, and it was burdened by a phony sense of prudence” (268).
Milken develops junk bonds into securities that have higher interest rates, extra fees, and behave more like stocks; as such, they can be added to a prudent portfolio. By 1987, “junk bonds were 25 percent of the corporate bond market” (272). They are so popular that Milken opens his own shop and, during one year, earns over $500 million.
Milken soon has more bond investors than companies who need loans. His team learns how to increase the issuance of junk bonds by arranging corporate takeovers that use a corporation’s own assets as collateral. It’s like taking out a mortgage on the company. Soon leveraged buyouts are common at major investment banks. Salomon, distracted by internal strife and leery of junk bonds, misses the opportunity. Worse, it has itself become the victim of the Milken/Perelman corporate raid.
Gutfreund convinces Warren Buffett, a wealthy American businessman and investor, to loan Salomon $700 million to help the company fend off the raid. Buffett receives a lavish options package and a 9% junk bond. The raid fails; Gutfreund’s job is saved.
Chapter 11 Summary: “When Bad Things Happen to Rich People”
The corporate raid fended off, Salomon suddenly wants in on the junk bond business. Its first deal involves the Southland Corporation, owner of 7-Eleven stores, whose managers want to borrow money to take ownership of their own company. Junk bonds are duly arranged, but buyers are few. Lewis, famous within Salomon for his ability to make difficult sales, is expected to be a rainmaker: “I was paying for my past by being sentenced to repeat it” (286). In the presence of a manager, Lewis calls his best customer and pitches the junk bonds, all the while sending signals not to buy. The client enjoys this immensely, and the manager, unknowing, walks away mollified.
Events at Salomon suddenly take a turn for the worse, and the junk bond sale is forgotten. In October of 1987, two departments, municipal bonds and money markets, are disbanded; 500 employees are let go. Four days later, during a fierce storm, 170 people in Lewis’s London bond office get laid off. Lewis’s job is safe: “I was considered, unbelievably, an old hand, partly because I had just enough friends in high places, and partly because I was one of the two or three biggest producers in the office” (295).
A few days later, Lewis is in New York to address the latest training class when the stock market suffers one of its worst crashes in history. The equities department parts with $100 million on one bad investment alone. Investors rush into money market funds, but Salomon has just sacked that entire department. Meanwhile, junk bonds collapse because the stock values of the corporations they support have plummeted. Salomon’s fledgling junk bond operation, including the Southland Corporation deal, lies in ruins. Happily, the bond traders make a killing, which blunts the sting. Salomon’s stock price drops below the company’s liquidation value, and many employees—including Chairman Gutfreund—purchase Salomon stock, which later rises back up. At year’s end, Salomon ekes out a small profit.
In December, Lewis receives the highest bonus package ever given to a two-year employee. Of his original class, much depleted from firings and resignations, he is now the best paid. Salomon is signaling that it wants Lewis to stay. Lewis decides to leave.
Epilogue Summary
In January 1988, Lewis resigns from Salomon. Money isn’t the issue: “I left, I think, more because I didn’t need to stay any longer” (307). He sees that it’s possible to make huge sums of cash without doing anything worthwhile. For Lewis, money no longer symbolizes his value as a contributor, and “without that belief, I lost the need to make huge sums of money” (308).
Chapter 10 - Epilogue Analysis
At about the same time Liar’s Poker is published, junk bond king Michael Milken is indicted for violating securities laws. He later pleads guilty and receives a $600 million fine and ten years in prison (reduced to two years for his cooperation). The bonds he invented, however, have become standard securities, actively traded. In later years, Milken funds charities and shows the health-care industry how to improve funding for research into deadly diseases. He has been hailed as a brilliant contributor to economic growth and, at the same time, reviled as a crooked trader who gained a billion dollars using questionable tactics.
After Liar’s Poker is released, Salomon goes through a number of course changes, scandals, and losses, including the destruction of their New York offices in the World Trade Center on September 11, 2001. In 2003 the company is absorbed into Citigroup, but not before its own innovations in the bond market became standard-issue securities traded to this day. Those mortgage bonds continue to evolve, leading to the development of low-quality subprime bonds and their derivatives, which in turn led to the 2007 economic crisis and the Great Recession. Nonetheless, mortgage bonds continue to play an important role in commerce.
Milken’s and Salomon’s innovations open the door both to useful financial improvements and serious abuse. From his perch near the center of this story, Lewis reports both the good and the bad and leaves it to the reader to draw conclusions.
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