Michael Milken: A Capitalist's Manifesto, Part III

In parts one and two, Michael Milken demonstrated the power of investments in health and education to lift nations and contribute to prosperity, and he showed how market-fueled innovation can have a profound impact on economic growth. In this third part, Milken, chairman of the Milken Institute, an independent think tank devoted to global economic issues, discusses the dampening effect that regulation can have on competition and growth. He also explains how through unconventional thinking about finance we can begin to solve our thorniest problems in energy, healthcare, and the environment.

A Crash Course in Finance

When you go to business school they traditionally teach you that to understand a company, first you have to look at the leaders of the company—the human capital—and assess their capabilities. Then, you need to look at the company’s capital structure. Once you understand the company, they teach you to look at the second level, the industry. What’s happening in that industry and how does it reflect on the company’s prospects?

As you move into more sophisticated levels of study, you begin to understand the market. Everybody knows that the worst time to finance is when you need money and the best time to finance is when you don’t need money. So the definition of a bank is an organization that will loan you money when you don’t need it and will not loan you money when you need it. The next and fourth level is what’s going on in the economy and what’s likely to happen when conditions change. When you can answer that, I believe you are allowed to graduate.

The Fifth Level: Regulation

Now those are the levels you’re traditionally taught. But there is another level, which I will refer to as the fifth level, which is much more important in the running of a business. That level is principally concerned with regulation. Government can put any company or any organization out of business any time it wants to. Bill McGowan [former chairman of MCI Communications] used to tell me that there were bills introduced in Congress weekly that if passed, would have put MCI out of business. This is not a new idea. If you go back and study English history, you will find that when the nobles—the lords—could no longer compete against the merchant class, they whispered in the king’s ear. “It is not fair. We’re the nobles. They’re the peasantry,” they would say. “We can’t compete. We need new rules. We need new laws. Something has to happen. Tax them. Do whatever you can, but we can’t have these merchants and mercantile class running around here. It’s interfering with our fox hunts.” So this phenomenon has been going on for hundreds of years. If you are royalty and competition becomes annoying, you go tell the king. In democracies, you don’t have kings, so you have to go tell the regulators.

In 1993, something happened that affected every one of our lives, although you might not even know about it. We installed a new health plan in America, and the value of pharmaceutical stocks plummeted. At the time, Merck was the most admired company in America, and in the world for that matter, for seven consecutive years. Then in one year, its stock dropped 50 percent. And that was the end of the pharmaceutical industry as you and I know it today. It was a mistake. The market perceived that the government was going to regulate the rate of return, and that the pharmaceutical risk takers were going to begin acting like utilities. So why would any company take a risk on investments in new drugs if they’re only going to get a regulated rate of return?

That wasn’t the exact proposal, but it was misunderstood by the markets (as government intentions often are) and thousands—tens of thousands—of medical researchers’ jobs were eliminated. For example, one company, GlaxoSmith-Kline, cut half-a-billion dollars out of its budget for cancer research. So if you needed to get your profits up, you just cut a billion dollars out of research—a short-run strategy to be sure, but something to shore up your stock. And so that’s what they did.

Perhaps an even more pointed example was when I met with Mikhail Gorbachev in 1988. The Russians were beginning to think about entrepreneurism. We were in Washington, D.C., and I told Gorbachev that somewhere between 7 and 9 of every 10 start-up companies resulted in failure. And Gorbachev asked, “Do you put the people running them in jail?” His idea, which was bureaucratic logic, was that if the idea doesn’t work, someone has to pay. So I tried to convince him that he just might discourage risk-taking a little bit with that approach.