Milken often spoke to students at business schools. On these occasions he liked, for dramatic effect, to demonstrate how hard it actually is to put a large company into bankruptcy. The forces interested in keeping a large company afloat, he argued, are far greater than those that wish to see it perish. He’d present the students with the following hypothetical situation. First, he’d say, let’s locate our major factory in an earthquake zone. Then let’s infuriate our unions by paying the executives large sums of money while cutting wages. Third, let’s select a company on the brink of bankruptcy to supply us with an essential irreplaceable component in our production line. And fourth, just in case our government is tempted to bail us out when we get into trouble, let’s bribe a few indiscreet foreign officials. That, Milken would conclude, is precisely what Lockheed had done in the late 1970s. Milken had purchased Lockheed bonds when the company looked to be heading for liquidation and had made a small fortune when it was saved in spite of itself, just as Alexander had bought Farm Credit bonds when all seemed lost but wasn’t. What Milken was saying was that the entire American credit-rating system was flawed. It focused on the past when it should have focused on the future, and it was burdened by a phony sense of prudence.

Milken plugged the hole in the system. He ignored large Fortune 100 companies in favor of ones with no credit standing. To compensate the lender for the higher risk, their junk bonds bear a higher rate of interest, sometimes 4 or 5 or 6 percent higher, than the bonds of blue-chip companies. They also tend to pay the lender a big fat fee if the borrower makes enough money to repay his loans prematurely. So when the company makes money, its junk soars, in anticipation of the windfall. And when the company loses money, its junk sinks, in anticipation of default. In short, junk bonds behave much more like equity, or shares, than old-fashioned corporate bonds.

Excerpted from ‘Liar’s Poker’ by Michael Lewis, pages 255 -256