Journalism
America: What Went Wrong? Rigging the Game (Part 1)
In a 1985 report to its clients, Drexel Burnham recommended the purchase of Beverly Enterprises stock, saying there were many opportunities for expansion.
"There is still a formidable pool of small independents," the investment firm said, adding that "management's goal is a steady stream of small acquisitions..."
In a report a year later, Drexel Burnham predicted the company's profits would reach $86 million in 1987 and said "there is no shortage of growth prospects for Beverly."
And in May 1987, the Wall Street Journal reported that a Beverly executive had confirmed that estimates by securities analysts of profits for the year between $54 million and $71 million were "in the ball park."
It turned out to be a different ball park.
For Beverly's earnings—like the earnings of so many businesses built on debt—evaporated.
Instead of the $86 million profit forecast by Drexel Burnham, the company lost $33 million in 1987. It lost $24 million in 1988. And another $104 million in 1989.
As the company sought to cut costs, it developed a reputation for paying low wages and having a high turnover rate among employees. Those two conditions often led to substandard care.
The wages were so low, the staffing so minimal at some Beverly-operated nursing homes that regulatory authorities in one state after another cited the company time and again for patient neglect.
Beverly also lost a civil lawsuit in which damages were awarded to residents of its nursing homes in Mississippi who complained about a reduced quality of life due to general neglect and abuse.
And the National Labor Relations Board joined the critics when an administrative law judge in November 1990 cited Beverly for unfair labor practices at 33 nursing homes in 12 states.
In an article published in December 1988, recounting Beverly's declining fortunes, The New York Times reported:
"Perhaps the most damaging blow to Beverly's reputation occurred in California two years ago. The state alleged that poor care at a handful of Beverly's 90 homes caused nine deaths, and inspections turned up 50 life-threatening citations over a 15-month period."
All of which brings us to Mengabelle Quatre. Suffering from seizures and cancer of the brochial tubes, unable to walk without assistance and otherwise confined to a wheelchair, she was admitted to a Beverly nursing facility on Oct. 13, 1989.
Seven weeks later, on a quiet Saturday afternoon on Dec. 2, 1989, Mengabelle Quatre died at the age of 69 at the Beverly Manor Convalescent Hospital in Burbank, Calif., not far from the make-believe world of Hollywood film studios.
A few lines from her death certificate sum up what happened:
"Death was caused by: Thermal injuries."
"Manner of death: Accident."
"Describe how injury occurred: Clothing caught on fire while smoking."
Confined to a wheelchair in a facility operated by Beverly Enterprises—the banner draped over the entrance proclaims "Love Is Ageless; Visit Us"—Mengabelle Quatre, a printer in a movie lab for 35 years, burned to death, in the middle of a hospital, while she was smoking a cigarette.
State investigators later described the incident:
"(An employee) stated in an interview that at approximately 3:10 p.m. on Dec. 2, 1989, he heard someone screaming, ran to the patio adjacent to the TV room where he observed (the patient) on fire. He extinguished the fire and yelled for someone to call the paramedics."
Mrs. Quatre was taken to an acute-care hospital where she died five hours later.
According to the state investigation, "the county coroner reported that the resident had died of thermal burns...of yellow-brown to black discoloration over 50 percent of her body. The burns ranged between her front mid-thighs to the top of her head."
A California Department of Health Services investigation concluded that Beverly Enterprises "failed to ensure that (Quatre) smoked only in a designated area under supervision" and failed to implement a "plan which required the patient's smoking materials to be kept at the nurses station and the patient to smoke in a designated place supervised by the staff."
LIFE ON THE EXPENSE ACCOUNT
The government rule book that helped create the environment in which Mengabelle Quatre died also makes possible quite a different lifestyle.
Meet Thomas Spiegel.
He is the former chairman and chief executive officer of Columbia Savings & Loan Association, a Beverly Hills-based thrift that the New York Times described in February 1989 as an institution that "has been extremely successful investing in junk bonds and other ventures."
Spiegel is a major fund-raiser and financial supporter of political candidates, Democrats and Republicans alike. He and his family live in a six-bedroom Beverly Hills home—complete with swimming pool, tennis court and entertainment pavilion—that could be purchased for about $10 million.
Spiegel thrived at Columbia during the 1980s, a time when the executive branch of the federal government loosened regulatory oversight of the savings and loan industry.
Working with his friend and business associate, Michael Milken, whose Drexel Burnham Lambert Inc. office was just down the street in Beverly Hills, Spiegel used depositors' federally insured savings to buy a portfolio of junk bonds, the high-risk debt instruments that promised to pay big dividends.
Columbia's profits soared. Earnings jumped from $44.1 million in 1984 to $122.3 million in 1985 and $193.5 million in 1986, before trailing off to $119.3 million in 1987 and $85 million in 1988.
Spiegel's compensation for those years averaged slightly under $100,000 a week.
He spent $2,000 for a French wine-tasting course, $3,000 a night for hotel suites on the French Riviera, $19,775 for cashmere throws and comforters, $8,600 for towels and $91,000 for a collection of guns—Uzis, Magnums, Sakos, Berettas, Sig Sauers.
Not unusual outlays, you might think, for someone who collected a multimillion-dollar yearly salary. Only in this case, according to a much-belated federal audit, it was Columbia—the savings and loan—not Spiegel, that picked up the tab.
There is, to be sure, nothing new about lavish corporate expense accounts. The practice of converting personal living expenses to a deduction on a company or business tax return has been around as long as the income tax. It is a practice that Congress has been unable to come up with rules to effectively curb.
But in the 1980s, corporate tax write-offs for personal executive expenses as well as overall corporate excesses—from gold-plated plumbing fixtures in the private office to family wedding receptions in Paris and London—reached epidemic proportions.
The reasons varied. Among them:
* The pace of corporate restructuring brought on by Wall Street created a climate in which once-unacceptable practices became acceptable, indeed, were even chronicled on radio and television, in newspapers and magazines.
* In a monumental change in the rules, Congress deregulated the savings and loan industry, in effect opening the doors to the vaults of the nation's savings institutions, while at the same time discouraging meaningful audits or crackdowns when irregularities were detected.
* The Internal Revenue Service lacks the staffing and time to conduct the intense audits of companies that would uncover such abuses. And even if the resources were available, an impenetrable tax code places too many other demands on the agency.
All this made possible a Tom Spiegel—and an army of other corporate executives who lived high on their expense accounts.
Federal auditors eventually found that Spiegel used Columbia funds to pay for trips to Europe, to buy luxury condominiums in Columbia's name in the United States and to purchase expensive aircraft.
From 1987 to 1989, for example, Spiegel made at least four trips to Europe at Columbia's expense, the auditors reported, staying at the best hotels and running up large bills:
"...$7,446 for a hotel and room service bill for three nights in the Berkeley Hotel in London...for Spiegel and his wife...in November 1988."
"...$6,066 for a hotel and room service bill for three nights in the Hotel Plaza Athenee in Paris...in July 1989."
The Spiegels' most expensive stay was in July 1989 at the Hotel du Cap on the French Riviera, where the family ran up a $16,519 bill in five days.
When they weren't flying to Europe, the Spiegels spent time at luxury condominiums, acquired at a cost of $1.9 million, at Jackson Hole, Wyo.; Indian Wells, Calif., and Park City, Utah.
To make all this travel easier, Spiegel arranged for Columbia, a savings and loan that had no offices outside California, to buy corporate aircraft, including a Gulfstream IV equipped with a kitchen and lounge.
Federal auditors now say that Columbia paid $2.4 million "for use of corporate aircraft in commercial flights for the personal travel for Spiegel, his immediate family and other persons accompanying Spiegel."
Columbia wrote off those expenses on its tax returns, thereby transferring the cost of the Spiegel lifestyle to you, the taxpayer.
The Federal Office of Thrift Supervision has filed a complaint against Spiegel, seeking to recover at least $19 million in Columbia funds which it claims he misspent.
Spiegel's lawyer, Dennis Perluss, said Spiegel is contesting the charges.
"All of the uses that are at issue in terms of the planes and the condominiums were for legitimate business purposes," Perluss said.
But you are paying for more than Spiegel's lifestyle. You're also going to be picking up the tab for his management of Columbia.
After heady earnings in the mid-1980s, Columbia lost twice as much money in 1989 and 1990—a total of $1.4 billion—as it had made in the previous 20 years added together.
Federal regulators seized Columbia in January 1991. Taxpayers will pay for a bailout expected to cost more than $1.5 billion.
That final figure depends, in part, on how much the government collects for the sale of the corporate headquarters on Wilshire Boulevard in Beverly Hills.
When construction started, it was expected to cost $17 million. By the time work was finished, after Spiegel had made the last of his design changes—"the highest possible grade of limestone and marble, stainless steel floors and ceiling tiles, leather wall coverings"—the cost had soared to $55 million.
It could have been even higher, except that one of Spiegel's ambitious plans never was translated into bricks and mortar.
According to federal auditors, he had wanted to include in the building "a large multi-level gymnasium and `survival chamber' bathrooms with bulletproof glass and an independent air and food supply."
Just whom Spiegel thought might attack the bathrooms of a Beverly Hills savings and loan is unclear.
AN INDIFFERENT CONGRESS
Congress has done little to curb the abuses of the 1980s.
Consider, for a moment, Congress' response to the leveraged buyout and corporate restructuring craze of the 1980s that led to the loss of millions of jobs.
As mergers, acquisitions, hostile takeovers and buyouts swept corporate America in the 1980s, defenders of the restructuring process contended it was merely another stage of the free market economy at work.
During an appearance before a congressional committee in April 1985, Joseph R. Wright Jr., then deputy director of President Reagan's Office of Management and Budget, summed up the prevailing attitude:
"There is substantial evidence that corporate takeovers, as well as mergers, acquisitions and divestitures are, in the aggregate, beneficial for stockholders and for the economy as a whole."
It is true that the restructuring of business is as old as business itself. So, too, the demise of corporations that are mismanaged or that manufacture products for which there is no longer any demand.
Once, the Baldwin Locomotive Works sprawled over 20 acres in Philadelphia and more than 600 acres in Eddystone, Pa. At the company's peak, it employed 20,000 persons.
When the market for steam locomotives disappeared, so, too, did Baldwin.
In those days, when factories and technologies died out—and workers lost their jobs—new factories, new technologies replaced the old. Always at higher wages.
But what sets the current era apart from the past is this: There are no new manufacturing plants to replace today's Baldwins. And the remaining jobs pay less.
While the government rule book encourages deal-making over creating jobs, rewards those who engineer new pieces of paper to be traded on Wall Street rather than those who engineer new products that can be manufactured and sold, Congress has displayed little interest in making changes.
From the mid-1980s on, lawmakers distributed news releases decrying corporate excesses.
They made speeches deploring the loss of jobs.
They conducted hearings exploring the possibility of enacting legislation to curb abuses.
They issued reports reciting their findings.
At one point, the flurry of activity stirred concern on Wall Street. An article in a January 1989 issue of the Wall Street Journal, under the headline, "Wall Street Fears That Congress Will Put Brake on LBOs," began:
"Fears are mounting on Wall Street that Congress may actually do something to slow down the gravy train of takeovers and leveraged buyouts."
The fears were misplaced.
Lawmakers were content with giving the appearance of action:
News releases. Speeches. Hearings. Reports.
But nothing else.
Especially no legislation.
As one congressional staff member put it when he explained why committee hearings trailed off:
"There simply is no interest among lawmakers in this."
Indeed not.
But Congress was merely following the lead of the White House and Presidents Reagan and Bush.
President Bush summed up his attitudes on corporate takeovers in a question-and-answer interview with Business Week magazine:
"To the degree that there are egregious offenses in these short-term takeovers that result in increased debt, I think we ought to take a look. But I have no agenda on that.
"I'm always a little wary about the government trying to solve problems when, historically, the marketplace has been able to solve them.
Members of Congress, for their part, seemed satisfied with the arguments mounted by the experts who insisted that all was working well and that new laws were unnecessary.
To Capitol Hill they came to testify, from the Harvard Business School, from Wall Street investment houses, from law firms specializing in mergers and acquisitions, from the offices of corporate raiders.
People like Carl C. Icahn, who spoke on the virtues of corporate takeovers during an appearance before a House Energy and Commerce subcommittee in March 1984.
Icahn already had made hundreds of millions of dollars in raids on such companies as Texaco Inc., Hammermill Paper Co., Uniroyal Inc. and Marshall Field & Co.
It was the year before he would take over Trans World Airlines Inc., a company from which he personally would extract millions of dollars, fire thousands of employees and pilot to the edge of bankruptcy.
Downplaying concerns about layoffs that follow mergers and acquisitions, Icahn told lawmakers:
"Generally, if the company is doing pretty well...there are not an awful lot of layoffs, and the layoffs that do occur are really getting rid of some of the fat that is not productive for society."
Similar views were expressed by Icahn's fellow raiders and others who profited from the restructuring of business—Wall Street investment advisers, bankers, lawyers, accountants, brokers, pension fund managers, arbitrageurs, speculators and a close circle of hangers-on.
This army of dealmakers turned the government rule book to its own advantage, seizing on provisions that place a higher value on ever-larger profits today at the expense of long-term growth, more and better-paying middle-class jobs and larger profits in the future. In doing so, they made billions of dollars.
Popular wisdom has it that the worst has passed, that it was all an aberration called the 1980s. The age of takeovers and leveraged buyouts. The decade of greed. And greed has been officially declared dead by trend-trackers. A higher economic morality is supposedly in for the 1990s.
Popular wisdom is wrong.
The declining fortunes of the middle-class that began with the restructuring craze will continue through this decade and beyond.
There are, an analysis suggests, two reasons:
First, there is the global economy—the current buzz-phrase of politicians and corporate executives. As will be described in a later chapter, the global economy will be to the 1990s and beyond what corporate restructuring was to the 1980s.
Through the last decade, decisions that produced short-term profits at the expense of jobs and future profits were justified because they increased "shareholder value." In the 1990s, the same decisions are being made with the same consequences—only this time the justification is "global competition."
Second, the fallout from the 1980s will drag on for years, as more companies file for protection in Bankruptcy Court, more companies lay off workers to meet their debt obligations, more companies reorganize to correct the excesses of the past.
WALL STREET'S GREATEST ACCOMPLISHMENTS
Meet Edwin Bohl of Hermann, Mo.
He, like Larry Weikel and Belinda Schell, knows all about the future.
The place to begin Bohl's story is with a company called Interco Inc., a once-successful Fortune 500 conglomerate whose products included some of the best-known names in American retailing—Converse sneakers, London Fog raincoats, Ethan Allen furniture, Florsheim shoes.
That was in 1988, the year the investment banking firm, Wasserstein Perella & Co., set out to reorganize Interco, a St. Louis-based company with scores of plants operating in the United States and abroad.
Interco could trace its origins back more than 150 years. It was one of the country's largest industrial employers, with 54,000 workers. It had annual sales of $3.3 billion. It had paid dividends continuously since 1913.
In the summer of 1988, a pair of corporate raiders out of Washington, D.C., brothers Steven M. and Mitchell P. Rales, targeted Interco for takeover, offering to buy the company for $64 a share, or $2.4 billion.
To fend off the Raleses, Interco's management turned to Wasserstein Perella, which came up with a plan valued at $76 a share.
Interco, obviously, did not have that kind of cash lying around. So the plan called for the company to borrow $2.9 billion.
The financial plan was the sort that Wall Street embraced with great enthusiasm. Supporters of corporate restructurings insisted that debt was a positive force, imposing discipline on corporate managers and forcing them to keep a tight rein on costs.
Michael C. Jensen, a professor at the Harvard Business School, was one of the academic community's most vocal supporters of corporate restructurings:
"...The benefits of debt in motivating managers and their organizations to be efficient have largely been ignored."
As it turned out, Interco failed to be a textbook model for the wonders of corporate debt.
Instead of encouraging efficiency, it compelled management to make short-term decisions that harmed the long-run interests of the corporation and its employees.
Within two weeks of taking on the debt, Interco closed two Florsheim shoe plants—and sold the real estate.
Interco announced that the shutdowns would save more than $2 million. That was—just enough to pay the interest on the company's new mountain of debt for five days.
At the Florsheim plant in Paducah, Ky., 375 employees lost their jobs. At the Florsheim plant in Hermann, Mo., 265 employees were thrown out of work. None was offered a job at another plant.
Hermann is a picturesque town of 2,700 on the Missouri River, about 70 miles west of St. Louis. Settled by Germans from Philadelphia in the 1830s, it remains heavily German. The town's streets are named after noted Germans. The local telephone book reads more like a directory from a town on the Rhine than one on the Missouri.
As might be expected from such a heritage, the deeply engrained work ethic served the town's largest employer well. Beginning in 1902, that employer was known down through the years simply as "the shoe factory."
It was a model of stability for the town and one of the manufacturing jewels of the International Shoe Co., later Interco, its owner. Because of the factory's efficient workforce, whenever Florsheim wanted to experiment with new technology or develop a new shoe, it did so at Hermann.
The plant had a long history of good labor relations. And it operated at a profit.
So why, then, did Interco choose to close the factory?
Listen to Perry D. Lovett, who was city administrator of Hermann when the plant shut down and who discussed the closing with Interco officials:
"We talked to the senior vice president who was selling the property and he told me this was a profitable plant and they were pleased with it.
"The only thing was, this plant and the one in Kentucky they actually owned. The other plants they had, they had leased. The only place they could generate cash was from the plant in Hermann and the one in Kentucky.
"He said it was just a matter that this was one piece of property in which they could generate revenue to pay off the debt. And that was it. That brought it down."
In short, a profitable and efficient plant was closed because Interco actually owned—rather than leased—the building and real estate. And the company needed the cash from the sale of the property to help pay down the debt incurred in the restructuring that was supposed to make the company more efficient.
Hardest hit by the closing, Lovett said, were the older people: "Here were folks who had never worked anywhere else...They had gotten out of high school and they went to work in the shoe factory..."
So it was with Edwin Bohl.
Bohl began as a laborer in 1952. "I think I started for 70 cents an hour," he recalled. Except for two years out to serve in Korea, he worked at the plant, rising to a supervisory position, until its closing 37 years later.
Announcement of the shutdown came without warning a few weeks before Christmas of 1988.
There was a meeting that morning, Bohl remembered, in which there was talk about increased benefits and changes in the way shoes were made. "They had given me a bunch of new chemicals," he said, "that I was to use in the finishing department. They had told us that everything was looking good."
A company executive was supposed to fly in from Chicago that same morning. No one said exactly why, but his plane was delayed.
"The minute we came back from lunch," Bohl said, "they called us supervisors together...The man read us the papers and said there were no jobs held for anybody...They told us they had to close the plant because of the restructuring...They had to raise money...They told (us) it was not because of the quality. We were rated the top in quality and cost...We had no idea this would happen."
Unexpectedly, Edwin Bohl found himself on the unemployment rolls at age 58.
He was given a choice:
He could wait until he reached retirement age and collect his full pension. If he did so, he would have to pay for his own costly health insurance.
Or he could take early retirement, with a sharply reduced pension, and the company would continue to pay his health insurance.
"I sacrificed 29 percent of my pension to get it (the health insurance)," he said, adding, "if I hadn't taken early retirement, my insurance would have been sky high. You really didn't have much choice."
Since then, Bohl, who was earning $19,000 a year at the shoe factory, has found part-time work in the local Western Auto store. The job pays $4 an hour.
Lamented Bohl's wife, Geraldine: "We thought this would be the best time of our life. Now he doesn't know when he's going to get a day off. You either take a poor retirement and have your insurance, or have your retirement and pay for high insurance."
As for Bruce Wasserstein and Joseph Perella, whose firm collected $9 million in fees for arranging the restructuring that left Interco with $2.9 billion in debt—which ultimately forced the company into U. S. Bankruptcy Court—they have a somewhat different perspective of their efforts at reshaping corporate America.
In February 1989, Perella modestly assessed his firm's contributions for the Wall Street Journal:
"No group of people—not just me and Bruce—ever accomplished so much in such a short period of time in Wall Street's history."