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Inflation Decade


December 30, 1970 - President Nixon signed The Securities Investor Protection Act of 1970; created Securities Investor Protection Corporation (SIPC), private nonprofit corporation to insure the securities and cash left with brokerage firms by investors against loss from financial difficulties or failure of such firms; first line of defense in the event a brokerage firm fails owing customers cash and securities that are missing from customer accounts.

1973 - Derivatives - Fisher Black, Myron Scholes published Black-Scholes Option Pricing Formula in Journal of Political Economy; specified first successful options pricing formula (mathematics of option pricing, dynamic hedging strategies using options and other derivatives); described general framework for pricing derivative securities, created financial engineering; one of most important mathematical tools in modem theory of finance (Black, F. and Scholes, M. [1973]. "The Pricing of Options and Corporate Liabilities". Journal of Political Economy, Vol. 86, p.637). 1997 - Black (posthumously), Scholes, Merton Miller awarded Nobel Prize in Economic Sciences "for a new method to determine the value of derivatives."

1974 - Michael Milken created market for high-yield bond trading; based on research of W. Braddock Hickman, former president of the Federal Reserve Bank of Cleveland (Corporate Bond Quality and Investor Experience, Princeton, NJ: Princeton University Press, 1958) - corporate default history 1900-1943: diversified long-term portfolio of non-investment-grade debt securities outperformed portfolio of investment-grade debt, with the same level of risk.

April 1977 - Junk Bonds - Drexel underwrote first junk bond issue, Texas International; end of 1978 - Drexel number one issuer; used financial innovation as low-cost solution to raising capital; created high-yield new-issue bond market; 1981 - issued bonds for leveraged buyouts; 1983 - provided junk bond financing for hostile takeovers (leveraged buyouts taken against incumbent directors' will); March 1985 - completed first junk bond-financed hostile takeover.

1977 - LBOs - Kohlberg Kravis Roberts & Co. (formed in May 1, 1976 by former Bear Stearns executives Jerome Kohlberg, Henry Kravis, George Roberts) financed $26 million leveraged buyout of A.J. Industries, publicly-traded small manufacturer of brake drums and other components (66% leverage financed with senior bank debt); firms' first deal; couldn't persuade anyone to provide subordinated debt (first LBO done in 1963 - Lewis B. Cullman acquired Orkin Exterminating for $62.4 million with a $1,000 investment); May 14, 1979 - acquired Houdaille Industries in $355 million buyout; first public-to-private transaction (leveraged buyout of a publicly traded company); took almost one year to raise $355 million from several banks, insurance companies for deal with 86% leverage financed by multi-layered array of senior, subordinated securities.

1977 - Securitization - Salomon Brothers (Lewis S. Ranieri) and Bank of America Corp. (BAC ) developed first private (non-Government Sponsored Enterprise) mortgage-backed securities (MBS); bonds pooled thousands of mortgages, passed homeowners' payments through to investors (only 15 states recognized MBS as legal investments); created "securitization," converting of home loans into bonds that could be sold anywhere in world = capital markets as source of funds for housing, commercial real estate; 1999 - size of market was $678 billion (41.6% credit card receivables, 19.8% home equity loans, 11.8% auto loans); 1982 - developed "collateralized mortgage obligation" (repackaged pools of 30-year mortgages into collections of 2-, 5-, and 10-year bonds to sell to wide range of investors; seen as template for cutting costs); led effort to obtain federal legislation to support, build the market (Tax Reform Act of 1986).

October 2008 - Size of Market for Derivative Products



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