The Federal Reserve System was established in 1913. The date was reported incorrectly in an article Tuesday.
The Reagan administration yesterday attacked a proposal by the Federal Reserve Board designed to curb the use of junk bonds in financing hostile corporate takeovers and other mergers.
In criticizing the Fed's proposal, the administration put itself on the side of takeover specialists such as T. Boone Pickens Jr., Carl Icahn and other so-called corporate raiders whose acquisition campaigns have relied heavily on junk-bond financing.
Junk bonds -- risky, high-yield securities that are rated below investment grade by bond-rating agencies -- have helped fuel the surge in merger activity in the 1980s. In effect, they permit billion-dollar takeovers to be mounted by individual "raiders" such as Icahn, largely using borrowed money -- a development that has troubled a majority of the Federal Reserve Board and led to the proposed restrictions.
The Justice Department, speaking on behalf of the Reagan administration, said that the Fed had exceeded its authority in proposing the restriction. There was no immediate reaction yesterday from the Fed, which has planned to put the restriction into effect on Jan. 1.
As it has in the past, the administration also defended the takeover boom as a healthy influence on investment, securities markets and the economy in general. Limiting the use of junk bonds would likely reduce the number of takeovers, removing an important source of pressure on corporate managements to operate their companies efficiently, the administration response said. That would harm "shareholders, investors, and consumers and impair the performance of the U.S. economy," said Assistant Attorney General Douglas H. Ginsburg, who signed the administration's response.
"There is no evidence that 'hostile' takeovers are less beneficial to society than friendly mergers," Ginsburg said, and without such evidence, government policy makers should be neutral.
His comments were seconded yesterday by the Securities and Exchange Commission, which argued that the Fed regulation would increase uncertainty about the legality of takeovers and mergers, delaying legitimate transactions. The SEC said it needed more time to evaluate the Fed's proposal.
The administration's response was in keeping with its favorable position on takeovers, detailed earlier this year in the Economic Report of the President. But the administration pointedly emphasized its objections to the Fed proposal by adding the weight of the Departments of Treasury, Commerce and Labor, and the Council of Economic Advisers and the Office of Management and Budget to Ginsburg's comments. The Justice Department would be the Fed's legal counsel if its proposal took effect and, as observers expect, was challenged in the courts.
The controversy began Dec. 6, when the Federal Reserve Board, by a 3-to-2 vote, proposed a new regulation that would require investors to put up cash or other assets -- rather than borrowing -- for at least half the cost of certain junk-bond mergers.
Fed Chairman Paul A. Volcker said the new regulation was needed because of a troubling increase in corporate debt caused in part by the rapid growth of junk bonds in takeovers.
One current example of the role of junk bonds is provided by GAF Corp. in its attempt to take over the much larger Union Carbide Corp. GAF proposed to raise nearly $3 billion of a $4.3 billion war chest through junk bonds, which would be issued if the takeover succeeds. The bonds would be backed by the assets of Union Carbide, the target. If GAF wins control of Carbide, it intends to sell about half of Carbide's assets to repay all or part of the junk-bond debt.
The Federal Reserve Board, which was created in 1934 in the aftermath of the great 1929 stock market crash, attempts to prevent stock market speculation by limiting investors' use of borrowed funds in buying stock.
The Fed's existing Regulation G, which applies to lenders, is designed to allow no more than half of a stock purchase to be financed on margin -- by borrowing.
The Fed's Dec. 6 decision applies that regulation to a common type of junk-bond financing in which a "shell" corporation with no assets of its own, set up by an acquiring company, sells debt to buy a target company's stock. The shell corporation uses the target company's assets to secure the debt. But indirectly, it is the stock of the target company that secures the debt, the Fed said. And that permits an extention of its 50 percent margin rule to such transactions.
The administration's response quarreled with that interpretation, saying the Fed was proposing a significant expansion of the margin requirement to cover public debt offerings. In the administration's view, junk-bond transactions essentially are offerings of debt, not stock.
Thus the proposal "threatens, for the first time . . . to establish the [Federal Reserve] Board as a regulator of the market for corporate control," Ginsburg said.
The Fed proposal was endorsed by a dozen members of the Senate Committee on Banking, Housing and Urban Affairs, whose response also was submitted to the Fed.
The senators expressed their concern that junk-bond transactions "may have a dangerous speculative influence on the private economy . . . In addition, we are concerned about the growing amount of debt, both governmental and private, in the country, and the real potential for a devastating impact on the nation's economy from defaults on private debt in the event the economy weakens."
It said the Fed's action "is a sound step in the right direction."