Junk Bond

What Is Junk Bond?

A junk bond, also called a high-yield bond, is a bond issued by a company or entity with a lower credit rating, meaning a higher risk that it will default. To attract investors willing to take on that risk, junk bonds pay higher interest rates than safer, investment-grade bonds. The high-yield market grew rapidly in the 1980s, closely associated with financier Michael Milken. Some savings and loan institutions, freed by deregulation to pursue riskier investments, invested heavily in junk bonds that later lost significant value, contributing to losses during the savings and loan crisis.

Why It Matters

Junk bonds matter because they show how the search for higher returns can concentrate risk in vulnerable institutions. During the 1980s, deregulation allowed thrifts — traditionally conservative home-mortgage lenders — to buy high-yield bonds and other speculative assets, and when those bets soured, the losses helped drive more than a thousand savings and loan failures. Milken's firm, Drexel Burnham Lambert, which dominated the junk bond market, collapsed in 1990 amid broader financial-sector stress. The episode illustrates a recurring pattern in financial crises: when institutions backed by government guarantees chase high yields, the resulting losses can ultimately fall on taxpayers, a form of moral hazard.

Test Your Knowledge

Questions on this topic from the EconRecall fact bank:

• Which financier, associated with the high-yield "junk bond" market of the 1980s, is sometimes linked to the S&L crisis since some thrifts invested heavily in junk bonds that later lost significant value?
  Michael Milken
• Which investment bank, closely associated with Michael Milken's junk bond operations, collapsed in 1990 amid broader financial-sector stress that included S&L troubles?
  Drexel Burnham Lambert