This Day in Dow History: The Beginning of Drexel's End

This article is part of a recurring series on Wall Street's storied past. All events presented here took place on this day in one or more of the years following the 1896 creation of the Dow Jones Industrial Index.

Drexel Burnham Lambert was once Wall Street's most profitable firm. Today, in 1988, it began to collapse.

Drexel's demise
The Securities and Exchange Commission charged the storied firm with securities fraud on Sept. 7, 1988. The 184-page complaint included charges of stock manipulation, defrauding clients, and violating a number of other securities regulations. Markets, including the Dow Jones Industrial Average (INDEX: ^DJI  ) , reacted with a shrug. Drexel would be bankrupt within two years, but the Dow would rise 27% from the date of the SEC's charges to Drexel's bankruptcy filing in February of 1990.

Drexel's history dates back to 1838, but the firm did not take on its infamous modern shape until 1976. Under Michael Milken's guidance, Drexel would become a leader and innovator in the field of speculative-grade bonds, earning Milken the nickname "Junk Bond King." These high-yielding bonds played a key role in the numerous leveraged buyouts and hostile takeovers throughout the 1980's, which led some in the media to call Milken's annual conference on junk bonds "the Predator's Ball."

In 1986, at the height of Drexel's success, nearly 4,000 takeovers, mergers, and buyouts took place in the United States, valued at a total of $236 billion. Drexel was instrumental in assisting Kohlberg Kravis Roberts' (NYSE: KKR  ) leveraged buyout of RJR Nabisco, helping to raise the $5 billion in funds necessary for the $25 billion acquisition even as it battled SEC allegations in 1988. The intense competition between firms that led to this record buyout price -- as Time once noted, "more than the gross national product of Peru or Portugal and twice the sum that Chevron paid for Gulf Oil in 1984 in the largest previous merger" -- would later inspire the book Barbarians at the Gate.

Michael Milken would plead guilty to six counts of securities fraud and spend 22 months in prison. Today, he is worth $2 billion and is influential in the for-profit education sphere as a founder and major stakeholder in K12 (NYSE: LRN  ) , which provides education to many thousands of students in online "virtual academies" nationwide.

KKR divested itself of RJR Nabisco by 1995, and the company split its tobacco and food divisions in 1999. RJ Reynolds is now a subsidiary of Reynolds American (NYSE: RAI  ) , and Nabisco is now part of Kraft (NYSE: KFT  ) .

A window to the future
Sept. 7, 1988 also saw the Federal Home Loan Bank Board begin a bailout process for the American Savings and Home Loan Association of Stockton, Calif. Up to $2 billion in financial assistance -- the largest individual bailout recorded up to that point -- was promised to American Savings, which was, at the time, the largest insolvent savings and loan in the country. Within months, nearly 300 more savings and loans with assets of $125 billion would be insolvent.

The New York Times ran a feature on technology and schools today in 1988. One Bureau of Labor Statistics employee was quoted as saying: "In the year 2000 it's hard to imagine anyone without a high school diploma being well placed in the job market. … We're gradually eliminating prospects for that."

The price of a barrel of oil fell 4% to $14.24 today. The conclusion of a long war between Iran and Iraq had caused traders to worry that the world would soon have more oil than it could handle.

The markets continue to change, but in many ways they stay much the same. A glance back at history can help explain the present -- or at least offer an interesting new perspective. It would be great to go back to the days of dollar-a-gallon gas, but those times are over. It's better to prepare for the future of energy with "The One Energy Stock You Must Own Before 2014." Invest in tomorrow's energy with the help of The Motley Fool -- find out more by clicking here.

Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more news and insights.

Motley Fool newsletter services have recommended buying shares of K12 and Chevron. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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