(FORTUNE Magazine) – FREDERICK JOSEPH, the head of Drexel Burnham Lambert, was precisely where no corporate executive wants to be when bad news hits -- out of the office. He had taken a few days off to rest and relax at his farm in New Jersey when Chase Manhattan Bank refused to extend Drexel's credit line. Coming due the following Monday was $30 million of commercial paper for the firm's commodities subsidiary. Says a Drexel managing director: ''The bank called up on Friday and said, 'Sorry, fellas, it's too risky for us. We're outta here.' We were caught with our pants down.'' There is usually a rough justice in life, but only in novels is it as swift and direct as the fate that overtook Drexel Burnham Lambert Group when it declared Wall Street's largest bankruptcy in mid-February. Greed and mismanagement destroyed the innovative, aggressive firm. Says Irwin Jacobs, a Drexel-financed corporate raider, of the greed that afflicted the firm: ''When you grab something that is too heavy, you break your arms. When you carry too much weight on your back -- no matter if it is gold -- you will break your back.'' From early 1989, when the firm agreed to plead guilty to six felony counts, it hurtled toward the dissolution that shocked Wall Street a year later. Why did the end come so fast? Who is to blame? Who will suffer the most? Joseph's initial surprise turned quickly to consternation that Friday afternoon when he arrived back in his office at the 11th-floor Drexel headquarters on 60 Broad Street in lower Manhattan. The commercial paper was an obligation of the holding company, Drexel Burnham Lambert Group, whose assets consisted of an illiquid junk bond portfolio. The firm's liquid capital was housed in its broker-dealer subsidiary, where there was in excess of $1 billion. The parent had been siphoning cash from the sub to meet its obligations until the transfers came to the attention of regulators at the Securities and Exchange Commission, which put a stop to them. The SEC insisted that the parent borrow against its own assets to raise capital, because the brokerage needed funds to protect its customers. The firm was in the vulnerable position of having its liabilities and illiquid assets in one entity and its liquid capital potentially unreachable in another. Joseph isn't talking, but one of the top people at the firm says, ''They took their eye off the ball when they set up the borrowing at the holding company level. It was just poor management. You have to have alternative sources of liquidity.'' JOSEPH and his senior officers began a round of meetings over the weekend. They wanted a $300 million to $400 million bridge loan from their banks and offered a portion of the holding company's junk bond portfolio as collateral. The junk market had been skidding for months, however, and the SEC was not willing to give the banks an implicit government guarantee for any loans to Drexel. As a result, the banks lost confidence in the firm, which was not likely to be any commercial lender's favorite customer anyway. For years the investment house stole corporate clients from the stodgy banks with the help of junk bond financing. If the banks delivered the first chop to Drexel's outstretched neck, the Federal Reserve was in charge of the guillotine. Fed Chairman Alan Greenspan and E. Gerald Corrigan, head of the New York Fed, were kept informed over the weekend of Drexel's desire to have the Fed help the firm by backstopping the bridge loan. There was a difference of opinion about whether a loan would save the firm, but it would buy time to liquidate the business in an orderly fashion. The Fed was apparently no more favorably disposed toward this scheme than were Drexel's bankers. The central bank must have believed the securities markets could withstand Drexel's collapse. Moreover, Fed watchers say Greenspan was sending at least two messages to Wall Street: ''We are not bailing out the junk bond business as we have the S&Ls'' and ''You can't plead guilty to six felonies and expect to be rescued by Uncle Sam.'' Drexel executives venture another interpretation shared by many on Wall Street. Says one: ''We were tough on the way up. We never made any friends. We stole business from other firms. We made the banks look silly. This was payback time. The Establishment finally got us.'' Adds G. Christian Andersen, a Drexel managing director in corporate finance: ''You've just seen someone try to bury Camelot and pretend it never existed.'' Monday was the meltdown. When word spread on the Street that Drexel's banks had withdrawn their credit lines, the firm's institutional customers stopped doing business with it. They feared Drexel would not be able to settle trades. Few were sorry for the firm. Says a New York City money manager: ''I can still remember the first time that I was stiffed.'' In 1982 this fellow had bought some bonds from Drexel at 60 cents on the dollar, and a few weeks later when he wanted to sell them, Milken's traders told him they'd take them at 50 cents even though there had been no change in the creditworthiness of the issuer or the condition of the market. The money manager continues: ''I said that I could understand a haircut, maybe 58 cents or even 57 cents -- but 50! I was told if I didn't like it I could try selling the bonds through someone else. I won't miss Drexel.'' THE ANNOUNCEMENT that the parent company had declared Chapter 11 came on Tuesday, and by Wednesday phones were ripped out of the firm's huge, gray ninth-floor trading room. Says a former Drexel broker who witnessed the scene: ''I've never seen anything so depressing in my life. Quotron machines were ! piled up. People were wandering around, so sad, so bitter. They don't know what happened to them.'' Adds a managing director in the mergers and acquisitions department: ''We knew when we got part of our 1989 bonus in pay- in-kind paper that the firm had a liquidity problem. Heck, that was the stuff we used to sell, not buy. But we had no idea that it would end in bankruptcy.'' What caused it to end that way is complex and controversial, and few want to take the rap, or the credit. But there are three people most responsible for Drexel's demise: Michael Milken, Rudolph Giuliani, and Fred Joseph. Milken took too far an imaginative scheme for giving smaller unrated companies access to the market. The key to Drexel's junk bond machine, and its eventual undoing, was Milken's ability to maintain a market, or the illusion of it, in the junk bonds Drexel underwrote for these issuers. In most cases, he was both the supply and the demand -- the only buyer when customers wanted to sell their bonds, and the only seller when customers wanted to buy. As long as everyone had confidence in Milken's ability to control the market, the game went on. By 1986 his machine had made Drexel Wall Street's most profitable firm, with earnings of more than $500 million on revenues of $5.3 billion. By 1987, however, Milken yielded to the temptation to milk his genius and began underwriting companies that were less creditworthy than earlier ones had been. A source close to Milken admits: ''Quantity became more important than quality. If Drexel couldn't market the security, they bought it for their own accounts rather than not do the deal.'' Unfortunately, when Drexel needed cash, this trash heap of private placements, junk bonds, and bridge loans, carried on the books for $2 billion, could not be sold for anywhere near that price. RUDOLPH GIULIANI, then U.S. Attorney for the Southern District of New York, began hunting the firm down with the help of Dennis Levine, a Drexel investment banker, and arbitrager Ivan Boesky, a Drexel customer, who both later pleaded guilty to securities-fraud-related offenses. Giuliani, who ran unsuccessfully for mayor of New York City, turned the Big Bertha of criminal prosecution -- the Racketeer Influenced and Corrupt Organizations Act (RICO) -- on his prey. Previously used to nail organized crime bosses and their henchmen, RICO gave Giuliani the power to close Drexel down before the firm's guilt or innocence could be proved in a court of law. The threat of being driven out of business scared Drexel's senior management. Says the Milken source: ''Giuliani put the gun on the table and said to us, Either you pick it up and use it on yourself or I will.'' Fred Joseph pulled the trigger: He agreed Drexel would plead guilty to six charges of mail and securities fraud, the firm would pay $650 million in fines and penalties, and Mike Milken would be removed from his position. Without Milken, the firm's one important franchise, junk bonds, began to unravel. Many of the biggest customers, like TWA's Carl Icahn and Revlon CEO Ronald Perelman, took their business to other firms that were beginning to poach more effectively on Drexel's theretofore private preserve. Having painted Drexel into a corner, Joseph failed to find a way out. As the junk bond market weakened in 1989, he approved the underwriting and warehousing of even more dubious bridge loans and junk bonds to protect the so-called franchise. As a result, Drexel wound up with huge positions, for example, in West Point-Pepperell, William Farley's distressed textile company. In trying to put the best face on a bad situation, Joseph compounded Drexel's problems. What he once described in FORTUNE as his ''surprising naivete'' verged on deceit. He said that Drexel would not settle with the government. It did. He said that he would not abandon Milken. He did. He thanked the retail brokers for standing by the firm, and then a few months later he took Drexel out of the retail business. Traders at Drexel's West Coast office began calling him ''Fred Isuzu.'' Joseph's most disingenuous moment came one week before the bankruptcy, when he told the Wall Street Journal: ''I see daylight. The worst is behind us.'' The company released unaudited 1989 financial results that showed Drexel with a plump net worth of $800 million and a mere $40 million loss for 1989. Subsequent events suggest that these numbers were more fiction than fact. The chief investment officer of a large Boston-based mutual fund organization received an unsolicited visit from Joseph before the year-end numbers were released to the public. It was a strange meeting, and Joseph's purpose was to say that Drexel was not going broke. By the end of the visit, however, this man was convinced that not even Joseph believed his own story. The collapse of the junk bond market in January and February revealed more about Drexel's dire straits than Joseph did. Traders feared that a hard-up Drexel and its equally strapped clients would dump billions of dollars of junk to raise cash. Bids evaporated. Even the best credits could not be sold in volume. What was the market saying? Answers the head junk bond trader for a large insurance company: ''Drexel was already dead meat.'' So too may be most employees, who will be looking for jobs at other firms in the midst of an industry slump. Some 1,000 of them owned stock in the firm, and those whose retirement depended on cashing in their shares have been wiped out. But don't feel too sorry for senior management; they were paid big salaries and didn't spend it all on $1,000 suits. Says Marc Faber, a managing director of Drexel's Hong Kong office: ''I hope they lose a hell of a lot of money, because they are the ones who brought the problems about.'' Drexel's institutional customers who bought junk at par and have yet to mark the degraded securities to current market prices will have to own up to enormous losses. Bids for some bonds issued at par have been as low as 10 cents on the dollar. Most vulnerable are insurance companies like troubled First Executive, which loaded up on Drexel private placements and other offerings that were not widely distributed. Also at risk are junk bond mutual funds such as the New America High Income Fund, a closed-end fund with at least 70% of its portfolio invested in securities Drexel underwrote. But most junk bond mutual funds have sufficient cash reserves to meet the anticipated redemptions by justifiably concerned shareholders. In a comically perverse twist to the story, two of Drexel's largest unsecured creditors could turn out to be Mike Milken and the Securities and Exchange Commission. The firm still owes Milken over $100 million in compensation that was to have been paid in 1988. The SEC stands to lose the final $150 million installment on the penalty that Drexel agreed to pay when it settled with the government in 1989. Will Drexel wind up stiffing them? They wouldn't be the first.