Too Big to Fail

by Andrew Ross Sorkin

  “Listen, I really need to do something,” Fuld told him. “Let’s do something together.”

  Mack had always genuinely liked Fuld and was concerned by the stress he could now hear in his voice. But he had no interest in entering into a deal and wondered if Fuld was deluding himself by even making the call.

  “Dick, I want to help, but it just doesn’t make any sense. We’ve talked about this before,” Mack said, reminding him of the meeting they had had at his house over the summer. “There’s so much overlap.”

  After getting off the phone, however, Mack continued to think about the possibility of a deal with Lehman and found that he was intrigued. His initial impulse about its unfeasibility may have been correct when Lehman’s stock was trading at $40 a share, but given its current price, a deal might well be financially attractive.

  “I’ve been thinking,” he said, after calling Fuld back. “I agree with you. We should talk.”

  After Fuld thanked him for reconsidering, Mack paused a moment and then said firmly, “Dick, I’m a very straightforward guy. I really like you, but let’s be clear, this is not a merger of equals. Only one person can run this. We have to get that up front now.”

  After an awkward silence, Fuld finally responded, “I wasn’t thinking that way,” and then, after another brief hesitation, added, “Let me think about it. I’ll call you back.”

  Twenty minutes later Fuld was back on the phone.

  “Look, you’re right,” he said, the toll that recent days had taken shading his voice. “I want to do the right thing. Let’s see what can be done.”

  Fuld suggested that they set up a meeting between the senior managements of both firms, without Fuld or Mack present; let them be the ones to decide if it was a good or bad idea.

  The gathering was arranged for that night at the apartment of Walid Chammah, Morgan Stanley’s co-president.

  Bob Diamond drummed his fingers on the desk as he waited on hold for Tony Ryan at Treasury, whom Bob Steel had suggested he call. “Tony,” Diamond began, “do you recall the conversation I had with Steel?”

  For a moment, Ryan was confused.

  “Which?” he asked, trying to act as if he knew what Diamond was talking about.

  “On Lehman.”

  “Oh, yes, yes.”

  “I wanted to call you because I thought it would it be worthwhile for me to talk to Hank. If not, no big thing, but my sense is that we should have a conversation.”

  Ryan said he’d get Paulson to contact him as soon as he could.

  An hour later Diamond’s secretary informed him that Tim Geithner was on the line. “What can I do to help this along?” he asked.

  Diamond explained that he was very interested in buying Lehman, if it could be had at a distressed price.

  “Why don’t you call Fuld?” Geithner asked.

  “You don’t understand,” Diamond said. “I am not trying to be provocative here.” He told Geithner about their experience trying to buy ABN AMRO—how the deal had fallen apart and how big an embarrassment it had been for the firm. “We don’t want to be seen as dabbling around,” Diamond said. “It would be inappropriate.”

  To Geithner, such unnecessary delicacy seemed characteristically British, even if Diamond was an American, and he just listened.

  “We need to be seen, to be invited by you and shepherded by you,” Diamond insisted. “You guys asked me if there was a price at which we’d be interested and you asked me, if so, ‘What do you need?’ That doesn’t mean I’m gonna call Fuld. That’s completely different.”

  Geithner, growing frustrated with his equivocation, asked again, “Why can’t you just call Fuld? Why can’t you do it?”

  “I’m not going to ask a guy if I can buy him, you know, at a distressed price,” Diamond said. “It only works if you guys are looking to arrange a deal. If you’re not, fine, no hard feelings, we’re okay.”

  However much Barclays may have wished to avoid giving the impression that they might be taking advantage of someone else’s misfortune, it was, of course, precisely what they were seeking to do.

  Ben Bernanke was finding it hard to focus as he sat in a meeting Wednesday afternoon with the local board of the Federal Reserve. Despite the chaos on Wall Street, he had continued making his regular visits to the Fed’s regional offices, and this particular trip had brought him to its St. Louis branch, located in a squat limestone building on North Broadway in the city’s downtown.

  The Lehman crisis, however, was never far away. He had already been on the phone with Tim Geithner and Hank Paulson twice about it, once at 8:30 a.m. and again at 1:00 p.m., with another conversation scheduled for 6:00 p.m.

  On the last call, Geithner and Paulson had informed Bernanke of their latest headache: Bank of America’s demand to have its capital ratio relaxed. “They are pissed off bigtime because they thought when they closed on Countrywide, they closed like big boys,” Paulson explained.

  Geithner argued that they needed to get Bank of America to New York by whatever means necessary so that they could begin their due diligence; he was concerned that they were losing critical time.

  Paulson asked Bernanke to call Ken Lewis himself and see if he could smooth the situation over, stressing again, “We need to get them a glide path.”

  From a temporary office at the St. Louis Fed, Bernanke dialed Lewis.

  “You really ought to come look at Lehman,” Bernanke urged him, still slightly uncomfortable about his new role as deal maker. “We’ll work with you on capital relief and anything you might need.”

  Lewis thanked him for the call and said he planned to send his men up to New York to start discussions with Lehman.

  Believing he had solved that problem, Bernanke returned to the reason for his trip to St. Louis: to visit with the staffers and spend more time with the St. Louis branch’s new president, James Bullard. Bullard had taken over in April from William Poole, one of the more outspoken Fed presidents, who, as it happened, was in Washington that day giving a speech about the Fed’s bailouts. Given the ongoing speculation in the market about the need for a government rescue of Lehman, Poole’s comments had been attracting an inordinate amount of attention.

  “Unless I’ve missed something, the Fed and Treasury have been silent about who might have access to Fed resources, except to say that Fannie and Freddie would have access,” Poole said during his speech.

  “The Fed said no to New York City in 1975 and no to Chrysler in 1979,” he reminded his audience, but “with the Bear Stearns precedent, it will not be so easy to say no next time.

  “What I anticipate is that we will not know the limits to Fed lending until the Fed says no to a large, influential firm seeking help.”

  Ken Lewis was leaning hard on the Fed. No sooner had he gotten off the phone with Bernanke than he placed a call to Tim Geithner. Lewis explained that he had had an encouraging call with Mr. Bernanke, but he still couldn’t send his team up to New York until the credit situation was officially settled.

  “We’re working to help you on this,” Geithner said, politely but firmly.

  Lewis, however, was beyond accepting such assurances. “We’ve been dicked around on this for too long,” he complained. “If you want us to get involved in Lehman, we’re going to need something in writing.”

  Geithner, taken aback at being presented with such an ultimatum, replied, “You’ve heard what the chairman said he would do. If you don’t believe the word of the chairman of the Federal Reserve, we have a larger problem.”

  Realizing that Geithner would not budge on the issue, Lewis finally backed down and agreed to send a team of executives up to begin due diligence that Thursday morning.

  As Wednesday wore on, Fuld tirelessly continued to work the phones—his call log was a list of virtually every major Wall Street and Washington player—while keeping a watchful eye on the markets for any further signs of panic.

  The news, it was becoming ever clearer, was grim: After holding up for most of
the day, Lehman’s shares sank in the last hour of trading, ending at $7.25 a share, a 6.9 percent decline. Lehman’s CDS had also blown out, rising by 135 basis points, to 610, which meant that the cost of buying insurance against it going bankrupt had just risen to $610,000 a year to protect $10 million of bonds. Investors were effectively betting that the situation was only going to worsen. Any hope that the SpinCo plan was going to turn Lehman’s fortunes around was quickly vanishing.

  Nor were the results of Fuld’s phone blitz encouraging. Earlier in the day he had had a tough conversation with Lloyd Blankfein, who had called to express his frustration that Lehman had ended discussions with Goldman. Alex Kirk and Mark Walsh had held a two-hour-long meeting with Harvey Schwartz of Goldman and his team at a Midtown law firm that morning, but both Kirk and Walsh were skittish about opening up all their books to Goldman and quickly had shut down the talks.

  Fuld had also spoken to Paulson, who had tried to convince him of the merits of a deal with Barclays. But Fuld was uneasy with that prospect, he explained: With Bank of America already in the hunt, he didn’t want to do anything to jeopardize a deal with them.

  “Dick,” Paulson patiently reminded him, “Ken Lewis has turned you down multiple times; the other guys have expressed an interest. We need to pursue both of these options.”

  Fuld, however, seemed more interested in returning to the topic that had so long obsessed him: denouncing the short-sellers who, he told Paulson, “are going to ruin this firm.” He spent ten minutes again imploring Paulson to call Christopher Cox at the SEC to press him to instate a short-selling ban, to announce an investigation—anything that would give him an opportunity to recover. By late afternoon, Fuld was channeling Steven Berkenfeld, a Lehman managing director, whose office was just down the hallway, using his favorite catch phrase about the raids on Lehman’s stock: “Short and distort!”

  In London, Bob Diamond of Barclays was waiting in the bar of Fifty, a private club on St. James St., just off of Piccadilly. He had invited Jeremy Isaacs, the former head of Lehman’s European operations, for drinks. If there was anyone who could give him an accurate insider view of Lehman, if there was anyone who knew the numbers and culture, it was Isaacs, who had officially announced his plans to “retire” from the firm just four days earlier.

  Isaacs had left when it became clear that McDade was ascending. In truth, he probably ought not to have come to this drinks engagement, as he was in the midst of negotiating a $5 million severance agreement with Lehman that would literally be approved the following day. As part of the arrangement he agreed he would not “engage in detrimental activity” or “disparage the firm,” and would “keep company information confidential.”

  Tonight he would come as close as he could to breaking every provision in that document with the intention of helping Lehman survive.

  Walid Chammah’s apartment is one of only three town houses on Manhattan’s Upper East Side with its own doorman. The beaux arts limestone structure just off Fifth Avenue contains only nine apartments. Tucked away a safe distance from Midtown and the banker riffraff on Park Avenue, it was the perfect place to hold a secret meeting to discuss a merger between Lehman and Morgan Stanley. Chammah’s wife and children were in London, where he was normally based, so the group had the place to themselves.

  By 9:00 p.m., Chammah; James Gorman, Morgan Stanley’s other co-president; and the rest of the Morgan Stanley team were milling around his kitchen, waiting for Bart McDade and the Lehman contingent to appear. “Let’s at least go through the motions,” Chammah instructed his colleagues, “but acknowledge that this meeting wouldn’t likely lead to anything.”

  When McDade finally arrived with Skip McGee, Mark Shafir, Alex Kirk, and several others, the strain of the day was evident from their drawn and pale faces.

  Gorman had known McDade from when they were both directors on the board of SIFMA, the Securities Industry and Financial Markets Association. Only a week earlier they had had a tense conversation about Morgan Stanley’s exploiting Lehman’s turmoil by recruiting away its talent, including the firm’s best private-wealth advisers. Outraged, McDade had called Gorman and told him, “You have to back off. We got really big problems here, and this is killing us.” Ultimately, Gorman stopped the recruiting effort, and the two were seasoned enough professionals to have moved on.

  Chammah poured a bottle of Tenuta dell’Ornellaia 2001, a $180-a-bottle Bordeaux blend, in an effort to settle the mood while keeping things proceeding. Everyone quickly took a seat in the living room.

  McDade told the group that being there tonight all felt a bit déjà vu; only a few months earlier nearly every person in the room had met to discuss the very same topic. Only now—an observation he left unspoken—Lehman was desperate. He then began to explain that Lehman was exploring various options for raising capital: selling assets, or perhaps selling the entire firm. In case that wasn’t clear enough, he indicated that if Morgan Stanley was interested in buying the company, he wouldn’t press them on terms. He then added that “social issues” shouldn’t hold up a potential deal—code for the question of who would run the combined businesses. McDade had effectively just given up Fuld.

  “If you want any of us involved, we’ll be involved; if you don’t want us, we don’t have to be. It’s not about us anymore,” he said.

  Shafir told the men that a deal “might feel like a stretch,” but he thought there was an opportunity to remove a good deal of cost from both firms, which was, after all, the baseline logic behind any corporate merger.

  Despite Shafir’s optimistic spin on a potential deal, Chammah was well aware that an agreement of this magnitude would result in a bloodbath, with probably hundreds if not thousands of layoffs. He also knew that the upside in any merger could prove elusive.

  Then, for a good hour, the bankers went over the numbers and the various assets that Lehman owned to determine if there was anything among its holdings that Morgan Stanley might want. But as the discussion went on and papers were passed back and forth, it became clear there was no common ground. Chammah then acknowledged that he didn’t think Morgan’s board could move quickly enough to be of any real assistance to Lehman in any case—a signal that everyone in the room recognized meant that he believed that Lehman Brothers was simply too far gone.

  Soon after McDade’s team left, Gorman looked solemnly at his group, as if to remind them, It could be us, but said only, “We just watched guys who are staring into the abyss.”

  Shortly after sunrise, Greg Curl walked across the plaza of the Seagram Building, the thirty-eight-story masterpiece of architectural modernism and a Park Avenue landmark. He entered the lobby, checked his watch, and waited for his go-to adviser to arrive.

  Curl, Bank of America’s point man for a possible Lehman Brothers deal, had flown from Charlotte to New York with a team of over one hundred executives on Wednesday night to begin their diligence at Sullivan & Cromwell’s Midtown conference center. To assist them Curl had enlisted Chris Flowers, a private-equity investor whose specialty was the arcana of the banking industry. The two made for an odd couple, given that Curl was a Bank of America veteran with a low profile and had few Wall Street connections, while Flowers was a fast-talking, and often profane, former Goldman Sachs banker whose daring deals often landed him in the headlines.

  But as Curl had considered what to do about Lehman, his first thought was that he wanted Flowers at his side. Flowers could read a balance sheet in less than thirty seconds and was bold enough to offer an articulate and well-reasoned judgment of it. He had left Goldman in the late 1990s and started his own private-equity firm to invest in banks, a business in which he had done very well indeed, personally pocketing some $540 million from an investment in Shinsei Bank in Japan. He was regularly listed as one of the wealthiest men in America, and when he purchased a town house on the Upper East Side for $53 million, it set a record for Manhattan real estate.

  Curl trusted very few bankers, but Flowers was an exceptio
n. He particularly admired Flowers’s dispassionate, no-bullshit approach to deal making—and to life. In 2007, just before the credit crisis hit, they had bid together on Sallie Mae, the student-loan company. They soon realized the deal was a mistake, and for the rest of the year, they worked together to try to undo it. Curl hadn’t held the Sallie Mae investment against Flowers, largely because Flowers was ultimately able to get them out of it by invoking an escape hatch in the merger agreement, with ensuing legal fireworks.

  Flowers could be useful for more than just providing advice, as Curl knew that he might be eager to invest in Lehman alongside Bank of America. Curl thought that he might even be willing to take Lehman’s riskiest assets.

  When he had sought out Flowers just twenty-four hours earlier, Curl had found him in Tokyo, where Flowers had been in the middle of a board meeting of Shinsei. “You’ll want to look at Lehman Brothers, and we want to look at it in partnership with you,” Curl told him. “Can you get back to New York for this purpose?” Flowers hardly needed persuading and quickly arranged for a car to the airport to make the fourteen-hour flight back to Manhattan.

  When Flowers arrived, clearly wearing the jetlag on his face, he had brought along Jacob Goldfield, a fellow Goldman alum. (Goldfield happened to be the banker depicted in Roger Lowenstein’s When Genius Failed as surreptitiously downloading all of Long-Term Capital Management’s information into a laptop during Goldman’s attempt to assist the beleaguered firm; it was Goldfield whom Alex Kirk of Lehman had mentioned in his nervous comment to Fuld about providing information to Goldman Sachs a day earlier.)

  Goldfield also knew Lehman well—he had helped Hank Greenberg examine the firm back in the spring when Greenberg was part of a group of investors who bought $6 billion of common and preferred shares.