Sen. Pete Domenici (R-N.M.) yesterday introduced legislation that temporarily would halt hostile takeovers financed with so-called "junk bonds" and would prohibit federally insured banks and savings institutions from investing in them.
He noted the irony of Congress trying to reduce government spending by $52 billion at a time when Wall Street is engaged in $14 billion worth of takeovers "which could result in the infusion of massive corporate debt in the economy."
His bill would ban until Dec. 31 hostile takeovers in which at least 20 percent of the acquisition is financed by junk bonds.
A moratorium is one approach being proposed to slow down what appears to be an acceleration in corporate takeovers financed through low-grade, high-yield bonds. Another, introduced in the House, would deny tax deductions for interest on junk bonds.
The market for the bonds, which are so risky that they are rated below investment grade, now exceeds $100 billion. The bonds have been issued not only by "fallen angels" -- corporations fallen on hard times -- but also by "rising stars," in the words of Drexel Burnham Lambert Inc., the developer of junk bond financing.
In fact, said Drexel's managing director, G. Chris Andersen, more than 85 percent of all U.S. public corporations would be rated below investment grade if they applied for a rating.
Several authoritative studies have shown that the high return on junk bonds in the aggregate is sufficient to make up for any defaults. Yesterday, before the House subcommittee on telecommunications, consumer protection and finance, Chairman Timothy E. Wirth (D-Colo.) said the issue is not the risk presented by the bonds but the danger their use poses to target companies.
There were 14 major corporate takeovers last year exceeding $1 billion each. In hostile leveraged buyouts, typically 80 to 90 percent of the financing is debt.
Economists and regulators have expressed concern that excessive debt could cause corporate bankruptcies if the economy takes a downturn.
Federal Reserve Vice Chairman Preston Martin expressed concern about the potential for greater risk to the financial system. "It would be fair to say that one cannot really be entirely comfortable assuming that the risks of junk bonds are clearly understood, especially when the market has not been tested by some significant negative surprises -- which inevitably come," he said. He added the Fed would continue to monitor the situation.
Most junk bond buyers are sophisticated investors, such as pension funds and corporate raiders. Yet Martin and other witnesses voiced alarm at the growing number of unsophisticated savings institutions becoming involved.
The Federal Home Loan Bank Board estimates that $3 billion to $5 billion in junk bonds is held by thrifts.
One state-chartered California institution, Columbia Savings & Loan Association, reportedly had almost $1 billion of its total assets of $6.38 billion in junk bonds at the end of last year.
Federally chartered S&Ls are allowed to place a maximum of 10 percent of their assets in junk bonds, but several states -- including California -- place no limit on the amount state-chartered thrifts can invest in junk bonds.
Should these investments sour, the Federal Savings and Loan Insurance Corp. would be called upon to protect customers' deposits.
To protect the FSLIC, the bank board is expected to place restrictions on these investments soon.