In early December, the Federal Reserve Board announced that it intended to control the issuance of low-quality "junk bonds" in financing the acquisition of corporations in hostile takeovers.
This came in response to the phenomenon of "shell" corporations. Such corporations' only assets are equities of a "target" takeover company and the pledge of its assets and cash flow once acquired.
Against these so-called assets, billions of dollars of junk bonds have been issued. The proceeds were used to buy common stock, at a premium price, of the targeted company.
The Federal Reserve has been greatly concerned about the proliferation of all types of debt, but particularly by low-quality corporate debt.
Regulation Gthe regulation the board would turn to in this instancedeals with the margin requirement in purchasing stock. (Currently, the buyer needs to put up 50 percent of the purchase price, and the broker lends the rest.) The Fed proposed invoking the regulation to limit the stock that could be purchased through junk bonds to the margin requirement of 50 percent.
This would mean that hostile takeovers employing shell companies would need more assets, thereby making such takeovers more difficult.
The Fed asked for replies to its proposal by Dec. 23. The Reagan administration replied "in force" against the proposal, which would have been implemented on Dec. 31. Lined up against the Fed were the Departments of Justice, Treasury, commerce and Labor, as well as the Council of Economic Advisers and the Office of Management and Budget.
The administration opposed the Fed's action, saying it does not have the authority to implement it.
As explained by Douglas H. Ginsburg, head of the Justice Department's antitrust division, "the board's proposal would destroy the market for corporate control, which disciplines inefficent management and enables stockholders to mazimize return on their investment."
In other words, it impinged on the administration's free-market philosophy.
Obviously, this is a complex matter. Valid arguments may be presented not only from the standpoint of the Fed, but also from that of the administration and the "takeover artists."
The takeover artists appeal to efficient corporate management along with the promise of higher earnings for stockholders. The administration argues a free market can sort out all corporate ills, and dislikes the idea of extending the role of the Fed into the marketplace.
The Fed, on the other hand, sees the dangers stemming from low-grade, junk-bond debt, not only to the corporations that issue it, but also to uninformed buyers who purchase junk bonds.
Major buyers of "junk," such as savings and loands associations, can't afford to have this type of an investment default.
Regardless of valid arguments on all sides, the "junk-bond takeover syndrome" raises alarming questions.
Who is to say that new management in a takeover venture would do a better job with its new company when it is saddled with enormous debt? In effect, the risks have been shifted from stockholders to bondholders.
The federal agencies should quit squabbling over who has what authority to handle the situation and take action before an economic downturn tests the ability of these junk-bond issuers to survive.
If these corporations be unable to generate the necessary cash flow to service their debts, the resulting defaults and damage will make the failure of the Washington Public Power authortiy seem minuscule by comparison.