This week's multibillion corporate takeover play features T. Boone Pickens in an assault on Unocal Corp., a Los Angeles-based oil firm. Whether you view Mr. Pickens' raids as a boon to stockholders or a bane to industrial stability, you will probably agree that they shouldn't be financed at any risk to taxpayers who are the ultimate insurers of most banks and saving institutions. Unfortunately, that's not the case.
To finance the current phase of his "leveraged" takeover bid, Mr. Pickens needs to borrow more than $3 billion. That's a lot of money to raise on short notice. But Drexel Burnham Lambert, the Wall Street investment firm hired for the task, says it anticipates no trouble. Drexel Burnham specializes in selling "junk bonds," high-yield, low-rated corporate securities that have found increasing favor among corporate raiders who want a quick and easy way to raise big money.
Of course, these securities are very risky. If Mr. Pickens and his partners are thwarted in their takeover bid, the Unocal stock they have purchased with their borrowed money could tumble. Even if they succeed in acquiring Unocal, the company might stagger under its heavy debt burden. But since the junk bonds bear low ratings, sophisticated investors presumably have been warned adequately of their risk and are prepared to assume it.
But not all buyers of junk bonds are sophisticated investors. Many savings and loan institutions are desperately seeking high-paying securities to finance the higher interest rates they must now pay to attract depositors. Lacking the capital and skill to compete for more stable commercial and consumer loans, some S&Ls are turning to low-grade corporate securities, including some issued to finance recent corporate raids.
If these securities prove to be as risky as their ratings suggest, the first losers will, of course, be the savings institutions' stockholders. But if the institution is forced into bankruptcy, most of the cost will be shifted to the federal government which insures most deposits. In response to a recent letter from D.C. Del. Walter Fauntroy, Federal Reserve Chairman Paul Volcker expressed his concerns about financial institutions' backing highly leveraged buyouts. Federally chartered institutions are already forbidden to invest in low-grade bonds. That prohibition ought to be extended promptly to all federally-insured institutions.