Scrap over Junk

Wall Street's dealmakers have regarded junk bonds, the risky, high-yielding IOUs that have helped to fuel the current rash of mergers and acquisitions, as the juice that made the party go. Now the Federal Reserve is watering down the punch. Last week the board voted 3 to 2 to restrict the use of junk bonds in financing certain corporate takeovers.

The Fed's ruling, publicly announced to an overflow crowd of lawyers and lobbyists, stipulates that in certain cases junk bonds may represent no more than 50% of a takeover bid. To make an acquisition, shell companies--firms with no real assets--will be forced to pay half of the purchase price in cash. This could quash the efforts of crafty corporate raiders who have used nothing but junk bond debt to finance their billion-dollar takeover bids.

The Fed's new rule, however, is far from all-embracing. The regulation will not apply if an acquiring company has "substantial assets," including real estate holdings, manufacturing operations, or any cash-generating business, to back up the takeover. Nor would the use of junk bonds be prohibited when two firms make a friendly agreement to merge.

The board's action went against the view of the Reagan Administration, which believes that mergermakers should be unfettered by Government regulations. Federal Reserve Vice Chairman Preston Martin and Board Member Martha Seger, who were both appointed by President Reagan, voted against the measure. Martin warned that the central bank was "starting on a slippery slope" in adopting the rule, but the Administration indicated last week that it will not challenge the central bank's move.

On Wall Street, reaction to the ruling was mixed. Drexel Burnham Lambert, the investment firm that first used junk bonds, called the decision "unwise and unwarranted." Drexel points out that of the $18 billion worth of junk bonds issued last year, less than 20% was used in takeovers. One supporter of the Federal Reserve was Felix Rohatyn, a partner of Lazard Freres, an investment banking house, who has been a critic of the use of junk bonds in hostile takeovers. Said he: "This was a sound step to curb the most extreme uses of junk bonds."

Still, no one expects that either junk bonds or hostile takeovers will disappear in the wake of the Federal Reserve's new regulation. Wily Wall Streeters will undoubtedly soon discover new ways to finance their deals. Even Fed Chairman Paul Volcker predicts that corporate raiders will uncover "innumerable devices" to circumvent the new policy. When that happens, the central bank could decide to take further action.