Milken Interview: Accounting, Sept. 11, Cancer Research

The following are excerpts from an interview with Michael Milken, conducted at the Milken Institute in Santa Monica by Business Journal Editor Mark Lacter. The transcript was edited for clarity.

Question: The recent accounting scandals and Congressional hearings raise questions about whether U.S. financial controls are adequate. Do you think the incidents we’re seeing are anomalous or part of a bigger trend?

Answer: I think they’re isolated for the most part. You lose common sense. Sometimes, we just forget to put a pencil to things. If you could put a wire into the ground and borrow three or four dollars for every dollar of equity you put up, and that wire is now worth 10 dollars, every single person on the planet is going to put wires in the ground. Now someone has to use those wires eventually. You have to step back and understand that certain things just can’t happen. Things can’t grow at that rate on a compound basis for that long. If half the people in China have never even seen a telephone, much less made a call, they’re probably not all going to be on the Internet right away.

So to think correctly, you have to take both an inductive and deductive approach. I financed pay per view in 1969. Guy had a fantastic idea. I loved the idea and we backed it. We just made a mistake no one could order it. People wanted it, we were just 20 years too early. We had to wait for the technology to get hooked up for it to work. That is the issue. There are things that just defy reason.

Q: But what do you think of the accounting irregularities being reported?

A: Accounting has not changed. GM wrote off $60 billion one year in unfunded pension and medical. I don’t think these issues have ever changed. Our reporting standards are by far the best in the world. If I have land on my books that I bought at a dollar and it’s worth a million I can manufacture earnings anytime I want, but that doesn’t mean you get 10 times those earnings or 20 times those earnings. It’s really a question of good research, good analysis and trying to understand the issues.

What we’re seeing in the last few years is questioning the quality of the research that’s going on and somewhat of a loss in the check and balance of the system. You have a check and balance between the trading sales research groups and the origination groups, the investment banking groups. When investment banking dominates, then you lose the objectivity of the marketplace.

Q: Some would suggest that we’re entering a witch hunt atmosphere where companies will be afraid to restate earnings for fear of market reprisal.

A: There is nothing new under the sun. That’s this year’s issue. My point is, fundamentally, if you have a good business that makes sense, U.S. standards are by far the best in the world. The stock market, at 10,000, is still within 10 percent of its high. It’s still 10 times the size of what it was in ’83. So it’s your frame of reference. All these things pass because the world goes on and the economy goes on. I don’t believe these stories are dominating people’s lives. They might be dominating the political debate, but the key areas that people are concerned about are safety for themselves and health care and education and financial security.

Q: The world is so much different this year than it was for your last global conference. How would you compare then and now?

A: The world is amazingly resilient. If you look at consumer confidence today, it is substantially higher than it was in August. And it’s back to almost where it was at the beginning of ’01. The world goes on. Most of people’s lives go on.

Q: You did a short interview on CNBC in November and said words to the effect that the economy would do better than what was being forecast at the time.

A: When you’re 350 years old like myself, you have a longer perspective. The strength of the financial sector is that most people only have 5-year careers. Most people are in their 20s and 30s. They work a lot of hours 100 hours a week is not unusual it’s high energy, they do a lot of flying around, and they have courage because they have no knowledge of the past. That enthusiasm allows them to do things that someone else might have been hesitant to take chances on. Ultimately, you need some grounding and frame of reference.

Q: Economists typically use economic models to predict future results that are based on historical data. What do you think of that?

A: We should get my biases on the table. There is no market. There is a market of stocks. There is no bond market. There is a market of bonds. So if you had elected to invest in firms involved with security or technology, testing, sampling, imaging, you haven’t seen a boom market like this in your entire history. Health care service last year was a fabulous year. You tell me what market you’re in and we can decide how those markets are doing.

The 1990s were just a replay of the 1960s. By 1967, you had all the technology, electronics. Some of the stocks went up 100-fold. So their curves looked very similar to the latter part of the ’90s. Then they all went crashing down. Many of these companies had difficulties surviving the early part of the ’70s because they had the wrong capital structure. It’s hard to look back and understand why Amazon, with a $40 billion equity market cap, was selling convertible bonds. So the lessons of the ’60s, no matter how many times you tell people, were lost on many people in the latter part of the ’90s. We’ve just seen a replay.

The best analogy is the concept of looking at our freeways from 5,000 feet. When you look down, all those cars are moving together in some grand plan. There are all those little rows, it’s totally organized. Now you get into an individual car and that person is attempting to maximize their own situation. They may be trying to get from point A to point B as fast as possible. They may be looking for alternative routes. They may not want the person to get in front of them. So at the individual level there’s a lot going on. The beauty of the marketplace is that we’re operating in our own individual interest, but also in some sort of collective interest.

Q: Is L.A. better or worse off for having an economy of essentially small and medium sized businesses?

A: Losing financial companies, aerospace companies, energy companies, media companies is devastating from the social capital standpoint because you can’t go to the 100 large companies and look for contributions. New York was able to mobilize very quickly (after Sept. 11), getting the 100 largest companies to commit half million or a million dollars. Here we don’t have that luxury. Social capital is strengthened by the corporate headquarters, whether it’s the opera or schools or other community organizations. So from that standpoint we are weaker. It would be better to have that, plus everything else.

But having just large companies puts your community, your region in serious risk. Houston is going to be reeling from Enron. Enron, at least for five years, was the leader in that community. We don’t have that situation any longer in our city.

The resiliency of Los Angeles is just the huge number of entrepreneurs who have come here from around the world and this abundance of small and medium companies in numerous industries.

Q: Was it just a coincidence that all those companies were acquired by out-of-towners in the late ’80s and early ’90s or was there some rhyme or reason?

A: L.A. was the second-leading financial center in 1986. The most profitable savings and loans were here. If you wanted mezzanine capital to build your business, you came here. First Interstate and Security Pacific were stronger than Wells Fargo or Bank of America. You were seeing enormous changes and I’m sure the financial institutions in New York felt threatened by these changes.

Had First Interstate bought Bank of America, the world would be different. Dick Riordan in the early 90s tried. He said, “We’ve got to talk to the people at Great Western, at Ahmanson. They have to become an acquirer. Financial institutions are getting larger, there’s an economy of scale.” If the CEO at Washington Mutual had been the CEO from Great Western, our city’s history would have been quite different.

Q: But is it just a coincidence?

A: It’s the people at a particular point in time who were there. It’s a question of leadership. Los Angeles is much different today than it would have been had USC and UCLA had a policy in the last 30 years of technology transfer. It’s people, it’s government support and academic support.

Q: The Milken Institute is based here, not back east, where so many think tanks are located. Has it been hard establishing credibility?

A: Rand is less than a mile away. You have a very interesting perspective here that you don’t have from other places. You see the world before anyone else. Most of the things that happen in America occur in California first and most of the things that happen in California occur in Southern California first. Both good and bad. What might occur in Connecticut in 10 years is happening in Southern California.

Q: Tell us about being in New York on Sept. 11.

A: I was supposed to give a talk across from the World Trade center that morning. And I decided to listen to a presentation by Oracle in the morning and I moved (the time). I was literally calling them between 8:30 and 9 when the plane struck. I have a son who lives downtown. It’s impossible to forget that experience. But it’s also impossible to forget the experience of the day you were told you had cancer. These all become part of who you are.

Q: I remember some New York writers were questioning how the world could be getting back to normal so quickly.

A: The Friday after Sept. 11, I was in New York at Times Square. It was so crowded you could barely move. As I traveled around the country in October and November, there really was not a significant change. They sang more patriotic songs, they sang “God Bless America,” but the world went on. They went to school, there was the Friday night football game, and their lives went on. The world goes on. You have to deal what fate has brought you.

There was a famous French philosopher/psychiatrist who had this theory that if you’re in a train and you see a little ball bouncing, it doesn’t really mean very much unless you’re inside the ball. We lost the lives of 3,000 Americans, but on the other hand we have lost 4 million Americans to cancer since that day.

Q: Since being diagnosed with cancer, has your perspective changed in terms of dealing with people?

A: I’ve been involved in cancer since ’72 so it is personal. In the last week I’ve had five or six people of our executives whose wives or sisters who have been diagnosed with cancer. You know, it’s life. When you hit 50 or 60, it’s a reality.

You never know what a person is thinking about when you talk to him. You don’t know what another person has had to overcome in their life. When we launched Mike’s Math Club in all the elementary schools in South Central L.A., I used to go to Jaime Escalante’s class at Garfield High. And there was a young man there one day who didn’t have his math book. So he was borrowing someone else’s math book. Turns out that the night before his father got drunk, his math book was in the room where his father got drunk, and no one goes into the room when his father was drunk. So I’m just trying to say to you that you never know what’s gone on in an individual’s life.

Michael Milken

Born: Los Angeles

Age: 55

Profession: chairman of the Milken Institute; chairman and co-founder of Knowledge Universe

Education: bachelor of science in business at the University of California at Berkeley; MBA from the University of Pennsylvania’s Wharton School

Professional history: consultant at Drexel Harriman Ripley in 1969, later Drexel Burnham Lambert; headed high yield and convertible bond department at Drexel Burnham Lambert until 1990; started Knowledge Universe in 1996

Legal history: paid $200 million fine and served 22 months in prison for six counts of securities/reporting violations

Net worth: $770 million

Philanthropic causes: breast cancer, prostate cancer, AIDS research, inner city education and other education awards

Nonprofits: Milken Family Foundation, CAP CURE (Association for the Cure of Cancer of the Prostate), Milken Institute, National Prostate Cancer Coalition

Family: Wife, Lori, two sons and one daughter

Residence: Encino

Other interests: Wall Street Journal guest writer; author of two cookbooks