NCJ - THE FINANCIAL ROOTS OF HEADWATERS 1997

THE FINANCIAL ROOTS OF HEADWATERS
by Daniel Ihara

The roots of the Headwaters Forest controversy extend not only down into the soil of Humboldt County, but also back in time to the financial shenanigans of the 1980s. It is important to understand these roots as the federal government, stockholders and the courts search for resolutions to Headwaters-related issues.

First, Maxxam could not have taken over Pacific Lumber if not for junk bonds and the "Junk Bond King," Michael Milken. Junk bonds -- politely called "high yield, high risk" bonds -- have been around for a long time. But they didn't hit it big until Milken realized that a collection of junk bonds paid higher returns than safer investments, even taking into account the proportion of bonds that defaulted on interest payments.

And second, Maxxam could not have taken over Pacific Lumber if vast changes had not occurred in the savings and loan industry. In the late 1980s at the close of the Jimmy Carter presidency, interest rates and inflation shot up into the double digits. This left savings and loan institutions stuck with home mortgages paying 3 percent while banks and money market funds were paying triple that amount to depositors.

This was the first savings and loan crisis. But instead of biting the bullet and letting these savings and loans collapse, the Reagan administration, in the spirit of deregulation, allowed them to take on higher yielding, riskier investments.

At the same time, and also in the spirit of deregulation, the government reduced the number of government regulators reviewing savings and loan activity. What was retained, though, was government insurance of saving and loan deposits used for riskier investments.

Savings and loans now had funds and authorization to buy high-yield investments while being insured by the government, and Milken had the junk bonds to sell them. All that was lacking was something to buy with junk bond money. Enter corporate raiders and leveraged buyouts.

Corporate raiders borrow money to buy control of companies. Although their own assets may be small, corporate raiders borrow by using the assets they will acquire as collateral, or backing, for the millions (sometimes billions) of dollars that they borrow.

Corporate raiders make no profit if the amount they borrow simply equals the value of the assets they purchased, but there are ways such corporate takeovers can make sense.

One, if the company being taken over has assets worth more than the value of all that company's stock, then someone who gains control of all this stock could sell off the company's assets, pay off money borrowed to buy the company and come out ahead.

Or two, a corporate takeover could break implied contracts, agreements or practices that had allowed the targeted company to function in the past. For example, a company's management might have an unwritten commitment to provide long-term employment in exchange for employees' agreement not to strike for higher wages. Or there might be an unwritten policy that the company would practice voluntary sustained yield harvesting for long-term stability instead of short-term profits and fluctuating employment levels. There are those who argue such was the case with Pacific Lumber before the Maxxam takeover.

Pacific Lumber's Articles of Incorporation state:

"The board of directors ... when evaluating any offer of another party ... to merge or consolidate this corporation with another corporation ... shall ... give due consideration to ... all relevant factors, including without limitation the social, legal, environmental and economic effects on the employees, customers, suppliers, and other constituencies of this corporation ... on the communities and geographical areas in which this corporation and its subsidiaries operate or are located."

-- Articles of Incorporation 1981, Article 10



In addition,

"any dissolution or liquidation of this corporation (as would occur in a corporate merger) shall require the affirmative vote of not less than eighty percent (80 percent) of the outstanding shares of this corporation entitled to vote, if ... any other corporation, person or entity beneficially owns or controls, directly or indirectly, five percent (5 percent) or more of the outstanding stock of this corporation." (Article 6)

A lawsuit in Humboldt County Superior Court alleges that when the PALCO board or directors agreed to the merger Oct. 22, 1985, it "was under the erroneous assumption that Hurwitz held less than 5 percent of Pacific Lumber stock and therefore needed only 50 percent ownership (instead of 80 percent) to effectuate a merger."

Further, this suit alleges that

"Hurwitz ... along with convicted felons Milken, Drexel Burnham Lambert, and Ivan Boesky engaged in ... securities manipulations as part of the continuing plan, scheme, and unlawful conspiracy .... to defraud Pacific Lumber shareholders with resulting injury to the non-shareholder constituencies of Pacific Lumber, (which) constituted and was part of a pattern of racketeering activity." (Thompson et al vs. Hurwitz et al. )

Pete Stark and 12 other representatives in Congress last month asked the Securities Exchange Commission to "consider an enforcement seeking the disgorgement of any wrongful gains that may have resulted from the takeover of Pacific Lumber."

Finally, the latter part of the 1980s saw the collapse both of junk bond prices and many savings and loan institutions. One of the largest to collapse was United Savings Association of Texas, controlled by Charles Hurwitz. Its demise cost U.S. taxpayers $1.6 billion to bail out. The Federal Deposit Insurance Corp. is seeking recovery of $250 million and the federal government's Office of Thrift Supervision might recover more than $1 billion because of the collapse of Hurwitz's Texas saving and loan. The OTS suit is scheduled to be heard beginning Sept. 22 in Houston.

(Note: For additional information, The Last Stand by David Harris, now in paperback, tells the dramatic story of the takeover with its vivid cast of characters.)

Daniel M. Ihara is the economics consultant for Humboldt County and Redwood Region Economic Development Commission, and an economics instructor at Humboldt State University.