Too Big to Fail

by Andrew Ross Sorkin

  McCarthy and Sants also faced another looming problem, one that, in the grand scheme of things, may have seemed minor but was nonetheless important at that very moment: The London Clearing House, which clears many of the derivative counterparty trades across Europe, was scheduled to do a software upgrade that weekend that would switch all its transactions to a newer system. They had instructed the London Clearing House on Saturday to hold off on proceeding with the upgrade until they knew more about the fate of Lehman and Barclays, but were now being badgered for a final answer, as dozens of technicians had been engaged to handle the switch-over.

  “We shouldn’t allow this to drag on,” Sants said to McCarthy, hoping they could get an answer back to the London Clearing House. “We ought to try to contact Geithner and just make our position very clear.”

  They scripted out what McCarthy would say: “We feel as the regulator [sic], in the best interest of the global financial system, that it’s important you understand—we hope Barclays has already made this clear to you, but in the event Barclays has not made this clear to you—that we need the appropriate funding assurances both on the trading side and with regards to the asset issues if we’re going to allow this to go forward.”

  McCarthy said he would try Geithner one last time.

  On the thirteenth floor of the NY Fed, Hilda Williams, Geithner’s assistant, told him that Callum McCarthy was on the phone. Geithner finally took the call, explaining, brusque as ever, that he had been in back-to-back meetings trying to get a deal together for Lehman and apologizing for not returning his call sooner.

  McCarthy stopped him, saying that he was very concerned that he didn’t know anything about the deal being contemplated. He had a list of questions that he needed answered.

  “The capital requirements and, in particular, the transaction risk between the time of taking on the risk and the completion of the transaction leaves a very big open-ended exposure,” McCarthy said, keying in on his biggest problems with the deal. He explained that the FSA still needed to determine whether Barclays was properly capitalized enough to take on the risk of buying Lehman. And, he said, even if it was—which he suggested was a possibility—Barclays still would need to find a way to guarantee Lehman’s trades until the deal was completed. “I’m very doubtful Barclays can ever get to a position to fulfill the requirements, and it is far from clear that they will able to do so,” he said.

  Geithner had no idea that the FSA would take such an aggressive position and asked McCarthy directly whether the authority was formally saying it wouldn’t approve the deal.

  “It is completely impossible for us to take a view on whether these risks are risks that we would accept,” McCarthy replied, unless “you bring a proposal forward.” But, he added, since it was so late in the day—about 3:30 p.m. in London—the chances were remote they’d be able to come to a conclusion within the next several hours.

  McCarthy went on to present another problem: He said that Barclays could not guarantee Lehman’s trading obligations without a shareholder vote, which was a UK “listing requirement” for all publicly traded firms in Britain. However, not only was there insufficient time for such a vote, but he said that he wasn’t authorized to waive the vote requirement—only the government could do that.

  Geithner explained that, based on his conversations with Barclays, he thought the British government had already indicated it would be supportive of the transaction.

  “I have no indication that that is the case at all,” McCarthy said firmly, and then expressed anxiety, as Darling had to Paulson on Friday, about Barclays’ own health and that of the rest of the market.

  “Look,” Geithner said impatiently, “we’re going to have to decide in the next half hour what we do. Time is running out.”

  “Good luck,” McCarthy said curtly.

  Geithner ended the call and rushed into Paulson’s office, where the secretary and Chris Cox were speaking, and recounted the conversation.

  “I asked him if he was saying no,” Geithner said, “and he kept saying that he wasn’t saying no.” But clearly, Geithner complained, that’s exactly what he was saying.

  Paulson was beside himself. “I can’t believe this is happening now.”

  After a brief discussion of strategy, Paulson ordered Cox, who was the only regulator in the room with legal authority over Lehman Brothers, to call McCarthy. Cox, Paulson thought to himself with a sense of annoyance, was supposed to have prewired these very regulatory issues. “I don’t want to be left here holding Herman,” the Treasury secretary said, glancing at his zipper in case the joke wasn’t clear.

  Cox reached McCarthy on his cell phone in the living room of his two-story home in Blackheath, across the Thames River. After the FSA head patiently reiterated the problems that the Barclays deal faced, Cox suggested they could try to work around them, adding, “You seem to be very unsympathetic to this.”

  “No,” retorted McCarthy coldly, “I’m trying to establish the facts of life so that you understand them and approach this with some realism.”

  “You’re being very negative,” Cox insisted.

  “Look, you should understand, one of the great problems for us at this end is not actually being properly kept in the loop of what you’re up to,” McCarthy complained, growing increasingly agitated. “You must understand, we’re hearing things late in the day,” he said, ticking off a list of requirements that Barclays would need to meet. “We could have told you earlier which ones would run into problems and which ones wouldn’t.”

  Five minutes later Cox returned to Paulson and Geithner, notepad in hand, deathly pale.

  “They’re not going to do it,” he said. “This is a total reversal. They never said a word to us about this before!”

  Tom Baxter, the NY Fed general counsel, who had just walked in, couldn’t believe what he was hearing. “We’ve come this far, the money’s on the table,” he said in disbelief. “Didn’t they know this when they took the plane over here?”

  “I’ll call Darling,” Paulson said.

  In Edinburgh, Scotland, Alistair Darling, Prime Minister Gordon Brown’s Chancellor of the Exchequer, was preparing to head to London for the workweek, as he did every Sunday.

  It was about 4:00 p.m. local time, and Darling had been on the phone for much of the day with John Varley of Barclays, officials at the FSA, and Prime Minister Brown himself, trying to decide whether the U.K. government should approve the deal with Barclays.

  Darling had deep misgivings about the transaction, especially after he had learned from one of his staffers that Bank of America had dropped out of the bidding. Was Barclays going to be left buying leftovers? He had read all the coverage of the deal in the papers that morning, including an editorial in the Sunday Telegraph:

  Free things can still make expensive purchases. Investors should only get behind Diamond if he can prove two things: that he is retaining the kind of discipline that has been sadly lacking from the world’s leading banks in recent times; and that Lehman, as transparently as it is possible to prove, is a genuine bargain.

  Darling thought it was impossible that Barclays could have done a deep enough examination of Lehman’s books to be satisfied that the bank wouldn’t be exposed to extreme markdowns of Lehman’s assets in the future. Even worse, Darling had other problems on his mind: HBOS, the United Kingdom’s biggest mortgage bank, was struggling; he also knew that Lloyds was interested in buying them. Between Barclays, Lloyds, and HBOS, the entire British banking system, he thought, was at risk.

  As all these concerns ran through his mind, he answered the phone call from Hank Paulson.

  “Alistair,” Paulson said gravely. “We’ve just had a distressing conversation with the FSA.”

  Darling explained that he understood that they had been in touch and that there seemed to be numerous unanswered questions. “I have no objection in principle to the deal,” Darling said. “But you’re asking the government to take on a huge risk. We need to be sure w
hat it is that we are taking on and what the U.S. government is willing to do. The questions we are asking are not unreasonable.”

  “We’re at the end of the line here,” Paulson said, surprised at Darling’s position, and pressing him again about whether he was prepared to lift the requirement for a shareholder vote.

  “If this were to go ahead, you know, what would the U.S. government be doing? What are you offering?” Darling asked in return.

  Paulson reiterated that he was hoping the private consortium was coming together, but now Darling shifted the conversation and began peppering Paulson with questions about the United States’ contingency plans for Lehman’s bankruptcy. “Well, if Lehman is going into administration, we need to know because it will have implications over here,” Darling said before ending the call.

  “He’s not going to do it,” Paulson told Geithner in amazement. “He said he didn’t want to ‘import our cancer.’”

  For the next two minutes in Geithner’s office, a half dozen excited voices were speaking at once, until he finally quieted the group and asked, raising his voice for the first time the entire weekend, “Why didn’t we know this earlier? This is fucking crazy.”

  Paulson began to wonder aloud if President Bush should call Gordon Brown personally, but almost before finishing the question, he answered it himself. “There’s no chance,” he said, explaining that he thought that Darling had implied he had already spoken to Gordon Brown about the situation. “He was so far away from, ah, wanting Barclays to do anything,” he remarked of Darling.

  “Okay. Let’s go to Plan B,” Geithner said after a moment’s reflection. They agreed to assemble downstairs to relate the news to the bankers so that they could begin preparing for Lehman’s bankruptcy. Plan B was simple: Regulators would press the banks to unwind trading positions they had with Lehman and with one another in a way that minimized the impact on the markets.

  And then there was the next critical issue to address, Geithner said: “We have to deal with Merrill.”

  As they got up to leave, Paulson, clearly depressed, remarked drily: “If you’re going to ride the pony, sometimes you have to step in the shit.”

  A NY Federal Reserve security guard who had been searching for Bart McDade and Rodgin Cohen eventually found them on the first floor. “Secretary Paulson would like to see you,” he announced before escorting them to Geithner’s waiting room.

  Cohen was already uneasy, for while McDade had been sending out enthusiastic e-mails about the near-consummation of the deal, Cohen had overheard a number of government officials who seemed to be more circumspect about its prospects. McDade now also sensed that something was amiss and sent a message to Gelband while he was waiting, telling him, “There might be a holdup.”

  The door to Geithner’s office opened and out walked Geithner, Paulson, and Cox, all looking alarmingly dour.

  “We got the banks to agree to fund, but the U.K. government has said no,” Paulson announced.

  “Why? Who?” Cohen asked, incredulous.

  “It came from Downing Street. They don’t want U.S. problems infecting the U.K. system,” Paulson said.

  While McDade just stood mutely in shock, Cohen, who was famous for his equanimity, virtually shouted, “I cannot believe this! You have to do something!”

  “Look,” Paulson said sternly, “I’m not going to cajole them and I’m not going to threaten them.”

  Cohen was not finished.

  “I know a lever we can pull with the U.K. government,” Cohen offered. “I have a friend I can call.”

  Paulson just stared at him, shaking his head. “You’re wasting your time. The decision was made at the highest levels.”

  Cohen walked to a corner and dialed Callum McCarthy directly. They had known each other for years; Cohen had been Barclays’ lawyer in the 1990s when McCarthy worked there. But the look on Cohen’s face as he explained the situation told the story unequivocally: McCarthy was clearly not able to help his friend.

  “You’ve really got this wrong if you don’t think this is going to infect you,” Cohen told McCarthy, nearly begging him to reverse his decision. “By not doing the deal, it’s going to infect you.”

  Downstairs, Paulson, Geithner, and Cox entered the main conference room where the CEOs were still trying to coordinate funding Lehman’s real estate assets. The mood in the room had been noticeably upbeat as they continued to make progress.

  “Those of you who do not want to assist a Barclays deal can breathe a sigh of relief,” Paulson announced, somewhat awkwardly, and a number of bankers in the room did not understand what he was trying to convey until he formally announced that the deal was dead. “The British are not allowing for this type of guarantee; they can’t get it done by tonight; they need a shareholder vote.”

  “But we have the money!” Jamie Dimon said.

  “Isn’t this our closest ally in the world?” one of the bankers asked.

  “Guys, trust me,” Paulson said. “I know how to be a tough guy. I’ve done everything I can. There is no deal.”

  The general opinion in the room was that they had been blindsided; Paulson merely shook his head and declared that the British had “grin-fucked us.”

  Geithner steered the conversation to the necessity of setting up contingency plans. He said that Lehman’s holding company would file for bankruptcy that day. He also indicated that the government would open up an emergency trading session in the afternoon for all of the biggest banks to unwind positions with the firm.

  Finally, Geithner broached the idea of creating a revolving credit facility, which would effectively serve to help the next bank in trouble. The proposal was for a $100 billion emergency fund, with each bank in the room putting up $10 billion: $7 billion funded and $3 billion unfunded. Any one bank could withdraw up to $35 billion from it in the case of an emergency.

  At the end of the meeting, Paulson and Geithner pulled Thain aside and quietly told him, “We’ve got to talk to you.”

  “John, you see where we are with Lehman Brothers,” Paulson told Thain once they had seated themselves in a conference room. “You’ve got to do something here. We don’t have the authority it’s going to take if you’re looking for the government to save you.”

  “I’m working on it,” Thain said solemnly. “I’m trying to save myself.”

  Thain explained that he was working on two parallel paths: one to sell a small stake in the firm to Goldman Sachs, and the other to sell the entire firm to Bank of America. He said that he had had coffee with Ken Lewis that morning and that Bank of America was much farther along, but that he expected Goldman could move quickly, too.

  Geithner had heard enough; he had to brief Bernanke, so he got up and left.

  Paulson could tell that Thain might be leaning toward the Goldman investment option—he knew Thain wanted to remain CEO of Merrill—but instructed him to push forward on the deal with Bank of America.

  “John, you have to get this done,” he urged. “If you don’t find a buyer by this weekend, heaven help you and heaven help our country.”

  “I understand it’s not going through,” Bart McDade told Bob Diamond when he reached him at his desk at Barclays’ headquarters.

  “What do you mean?” Diamond replied, completely taken aback. “I haven’t heard that.”

  “It’s off. The government says it’s not happening,” McDade told him, and recounted Paulson’s discussion with the British regulators.

  Diamond immediately got off the phone and called Tim Geithner’s office.

  “I just heard,” Diamond said, exasperated. “What happened?”

  “You should talk to Hank,” Geithner told him.

  When he finally managed to reach Paulson, he said, somewhat curtly, “I want to tell you that it was really difficult for me to get a call from someone else well after you did this.” He paused, trying to keep his voice level. “And what I’ve been told you said is very much against what I think the facts are, and I think I deserve
an explanation.”

  When he hung up after hearing Paulson’s account of the communications, Diamond was in turn deflated, furious, and embarrassed. He was livid with Paulson and dismayed by the British government. How could they have led him so far only to quash the plan at the last moment?

  At 12:23 p.m., Diamond tapped out a message on his BlackBerry to Bob Steel, who had been trying to set the deal up for six months:

  Couldn’t have gone more poorly, very frustrating. Little England.

  Bart McDade, Alex Kirk, and Mark Shafir walked in silence through the underground garage at the NY Fed and piled into McDade’s black Audi A8 to drive back to Lehman headquarters. For at least five minutes nobody said a word as they all just tried to comprehend what had just happened. They had all come to accept that they were out of options.