Junk bonds history

The term given to bonds of less than investment-grade quality. There are two types of these bonds: those that were initially sold when the issuing company was low rated and those that were originally investment-grade bonds but later were downgraded in quality by the rating agencies.

Bonds of the latter type were previously called “fallen angels.” Traditionally in the U.S. capital market, only companies with investment-grade credit ratings were able to borrow on the bond market. Companies with less than investmentgrade ratings were normally forced to borrow from banks at higher interest rates and for shorter periods of time than they would have preferred, often altering their capital investment plans.

The market for original-issue junk bonds, technically high-yield bonds, was developed in the 1970s by Michael Milken at DREXEL BURNHAM LAMBERT. Many of them were issued as originalissue discount bonds, meaning that their coupons were set artificially low so that their yield to maturity would reflect their risk. When the bonds matured, the borrowing company would have to repay the full face amount—an amount above that which was raised originally. Many companies that were excluded from the corporate bond market made use of the junk market, and by the mid-1980s it had become a major corporate bond market sector in its own right. Junk bonds were also widely used in the corporate takeover and merger trend that developed in the mid-1980s.

Junk bonds became popular after the DEPOSITORY INSTITUTIONS ACT was passed in 1982, allowing thrift institutions to purchase them in limited amounts, reversing a long-standing prohibition against limited-purpose banking institutions buying corporate securities originally found in the BANKING ACT OF 1933. Their relative lack of liquidity in the secondary market became an issue after the savings and loan crisis in 1988, and the RECESSION in 1990–91 caused some junk bonds to default. But the market recovered in the mid-1990s, and junk bonds have become an accepted form of finance for companies that have not gained investment-grade status.

See also INVESTMENT BANKING; TREASURY BONDS.

Further reading

• Bruck, Connie. The Predators’ Ball. New York: Simon & Schuster, 1989. 
• Yago, Glenn. Junk Bonds: How High Yield Securities Restructured Corporate America. New York: Oxford University Press, 1990.