“It happened very quickly,” a source at the White House who was monitoring the situation told me. “In the days before their fateful weekend, they were trading at around $40 a share. Bear Stearns looked like a solvent company even as of Friday morning before it failed. We had these issues that we thought were liquidity issues, where the institutions simply couldn’t raise the money to cover their short-term obligations, but they were solvent in the sense that the value of their assets exceeded the value of their liabilities. The problem was that they became illiquid and they couldn’t raise the money, so they had to start dumping assets. And the assets no longer were worth as much as they thought they were. The liquidity crisis turned into a solvency crisis, and it happened, literally, within hours.”
When I spoke with Dimon the following month, he shook his head in amazement, recalling the weekend. “It’s the last time I will ever do something like that,” he said. “You have to know that there were two hundred people from JPMorgan and probably an equal number of people from Bear Stearns working around the clock. They didn’t go to sleep for a two- or three-day period. Just watching that teamwork of those folks was something special. But it was brutal. It’s unprecedented in a forty-eight-hour period that two companies and the government get together and pull off a transaction like that.”
The most brutal aspect of the negotiations was setting the price. “It was really hard to come up with a price,” Dimon acknowledged. “The question was, how much risk could JPMorgan bear? We wanted to make sure that JPMorgan was never put in a position where it was jeopardized in any way, shape, or form.”
What Dimon didn’t mention was that, behind the scenes, Paulson was pushing for a lower price, not wanting the appearance that the government was rewarding a failing company for its misdeeds. The concept he invoked was that of “moral hazard”; that is, if the government was seen as rescuing a company whose bad choices were responsible for its failures, other companies would not be discouraged from making similar bad choices. Paulson was also extremely sensitive to the fact that Bear’s rescue would be achieved with the backing of taxpayer money, and he was loath to abuse the privilege. Throughout the weekend the discussions about the bid seemed to range from $8 to $12 a share. But as time began to run out, the number started to shrink precipitously.
I was working at home when I got the call that Bear Stearns was being sold to JPMorgan for $2 a share. I couldn’t believe it. Perhaps my source had dropped a zero?
It’s hard to fully describe the consequences of such a low share price. To put it in context, a year earlier Bear was trading at around $170 a share. To no one’s surprise, shareholder rage in the wake of the announcement was intense. Amid charges of highway robbery, Dimon was forced to go back to the table and push the share price to $10. However, Dimon would later defend the rock-bottom original price to Congress with the explanation, “Buying a house is not the same as buying a house on fire.”
Ace Greenberg would later describe to me how heartsick he felt on that day. “My regret was that we had fourteen thousand marvelous people working for us that were so loyal, and many had been there so long. We had people who were challenged as runners and so forth, and they wouldn’t miss a day of work. Snow, subway strike, these people, believe me, were there every day. It was just marvelous. And I felt very bad. I was afraid they weren’t going to get jobs.”
Still, the sale was widely believed to be a success. A Treasury Department insider who was involved with the deal told me, “The reason Bear Stearns is important is because we could never have pulled off something so major in a weekend without everyone—the Fed, the Treasury, the banks—understanding how disastrous failure would be. Everyone knew the situation was dire—that we had to come up with a deal.”
With the sale in place, Paulson breathed a sigh of relief. They’d dodged a major bullet. One of his advisers said, “Well, you’ve had your big moment, Mr. Secretary. Bear Stearns will be what you’re remembered for.”
If only that were true.
THREE
Zombies at Lehman
“The investment banking model is a confidence game; it’s about funding. There’s no one in the world who could have raised money for Goldman, Morgan Stanley, Lehman, Merrill. Forget it. Everyone was like, ‘I’m staying out of this thing.’”
—A FORMER LEHMAN BROTHERS EXECUTIVE
SEPTEMBER 12, 2008
At the Federal Reserve, the CEO working groups labored on, late into the evening, trying to get a handle on the true condition of Lehman Brothers. The mood was tense and at times sorrowful. Later, I received a call from one of the men that was quite telling. “Paulson made it very clear that there would be no Fed bailout,” he said. “It’s up to us.” He sounded drained as he described sitting at a table at the New York Fed along with Geithner, Paulson, and the Lehman people. He said, “Across the table the Lehman guys truly looked like zombies. And it was at that moment that we all realized, ‘Oh my God, these guys could go bankrupt. They could actually file, and if they do, it’s going to impact all of us.’”
Meanwhile, Fuld and his team were closeted in Lehman’s midtown offices. As rain pelted the thirty-first-floor windows, they worked furiously to find a way to structure a deal that would be acceptable to a potential buyer. That meant packaging and unloading the toxic assets.
Paulson called Fuld Friday evening. “I told the group that they should think about a consortium to buy Lehman Brothers, and they turned it down,” he told him.
Fuld was disappointed but he kept pushing. “We need another idea,” he told his team, and one of the men in the room said, “Okay, I have a different idea. Why don’t you just get them to guarantee the debt on the commercial real estate. That’s the thing people are pointing the finger at. That’s why they’re asking, ‘Is there a hole in the balance sheet?’ We put in $10 billion of equity, and the debt’s guaranteed by the consortium—say another $30 billion. Checkmate. Done.”
Fuld called Paulson back and floated the idea.
“Great. I’ll bring it into the room,” Paulson said.
He called back within a half hour. “No, they don’t want to do that.”
“It was frustrating,” Scott Friedheim, the chief administrative officer and one of Fuld’s closest allies and advisers, recalled later. “We’d come up with idea after idea, and every single one of them got shot down.” He felt exhausted and demoralized.
Scott Friedheim was a young man, only forty-two, but his body was screaming at him, “Slow down, slow down.” That was the one thing he could not do. In the months leading up to September 12, he had been putting in seven-day weeks, and very long days. Later he would tell me with a wry laugh, “When I heard people saying they didn’t sleep for a week during the peak of the crisis, I thought, ‘Oh my God, for us it’s been since March.’ We were in full-battle mode all quarter long. We were in there every frickin’ weekend.”
In early August, on a rare Sunday afternoon away from the office, Friedheim was visiting a colleague at home. “He had a small basketball hoop for his kids, and I went to dunk it in the short basket,” he recalled. “I didn’t even get off the ground. I just planted my leg and a tendon popped out of my hip, broke the hip and tore the labrum, and I went down. I had to be in the office the next day, and I was there, popping Tylenol and in tremendous pain. My doctor said, ‘Stay in bed, rest, keep off the hip for three months.’ Yeah, right.”
To further complicate matters, he was getting married in the South of France over Labor Day weekend. He almost didn’t make it.
Two weeks before the wedding, while Friedheim was still hobbling on crutches, Dick Fuld came into his office. A five-ten former weight lifter, Fuld was an intense guy, and now he directed the full force of that intensity on Friedheim, saying, “I’ve got good news and bad news.”
Friedheim didn’t crack a smile. “Give me the bad news,” he said with a sense of doom.
“You can’t go,” Fuld said.
“To my wedding?”
&
nbsp; “Right.”
Friedheim was so flabbergasted that all he could think of to say was, “And the good news?”
Fuld gave him an intense look. “The good news is I need you.”
Friedheim felt a momentary surge of exhausted resentment. He hadn’t had a full day off in a year, and now this. He started explaining to Fuld the magnitude of the wedding event. “I have four hundred people coming to the South of France, and most of the families are already there at the château we rented,” he said, “and you expect me to just say I’m not coming?” He didn’t bother stating the obvious, that it wasn’t just the inconvenience of it—it was his wedding day, arguably one of life’s most significant moments, and his boss was telling him to choose the company over his fiancée and his personal future. If he hadn’t known Fuld better, he would have called the suggestion that he miss his own wedding stone-cold preposterous. But Fuld wasn’t cold. He was just focused—a surgeon with his arm already elbow deep in his patient’s chest cavity. Lehman was on life support and there was no time for niceties.
That Friedheim didn’t go ballistic was a credit to the loyalty Fuld inspired. In spite of his lack of personal charisma, Fuld evoked something akin to a cultlike fervor among his staff. Lehman Brothers was like a religion to them, worthy of any sacrifice. It was also like a family, growing more close knit in the face of crisis. When Fuld challenged his workers to “bleed Lehman green,” they were proud to comply, if not literally, then emotionally.
Friedheim did some quick calculating, trying to figure out how he could meet Fuld’s demand and still show up for his wedding. He canceled his flight and booked a red-eye that would put him on site hours before the ceremony. He made it, but he was so dead tired that after one dance with his new wife, Isabelle, he said, “I’m sorry. I’ve got to go to sleep. I’m exhausted.”
He slept for a few hours and took the earliest flight back to New York, still negotiating on crutches. Not exactly a romantic weekend. “It was absolutely brutal,” he recalled, and yet in a funny way it seemed completely justified. He’d been with Lehman for eighteen years, loyal and dedicated. Lehman was his first wife, and Friedheim was desperately trying to save his marriage. And although that meant getting off to a precarious start in his marriage to Isabelle, he didn’t hesitate.
The urgency had been building ever since Bear’s fire sale to JPMorgan. As much as everybody would have hoped that Bear Stearns was the finale of the crisis rather than the beginning, it was immediately evident that it was a harbinger of worse things to come. The investment banking model was being called into question. From the outset, the Fed was concerned about Lehman. Its similarities to Bear Stearns were inescapable—in particular, poor liquidity and too many real estate assets. Indeed, rumors that Lehman would be the next investment bank to fall sent its shares plunging by nearly 50 percent the Monday after Bear’s sale. Bank executives would later tell me that the assets owned by Lehman were significantly riskier than Bear’s or any other firm’s.
Thursday, March 20, 2008, I interviewed Lehman’s CFO, Erin Callan, on Closing Bell. Callan was an anomaly on Wall Street—a young, forty-two-year-old woman in the top echelon of a legendary firm. She was smart, pretty, and media savvy, and although she had not been in her position long, she had increasingly become Lehman’s public face and primary cheerleader. Some people suggested that Dick Fuld, who hated appearing in the media, sent her out so he didn’t have to go. Fuld was always awkward around the press. He never really knew how to be the face of Lehman, and he wasn’t interested in playing the role. He despised the snarky attitudes and personal slights—such as the way he was dubbed “the gorilla” in the press. He spoke to reporters only on background.
Callan was not universally popular inside Lehman. Sources told me they worried that Fuld pushed her out front too much, and not always to positive effect. She was unquestionably bright and ambitious—a Long Island girl who rose to become the first female member of Lehman Brothers’ executive committee. She was mentored by Lehman president Joe Gregory, and he thought the world of her. But others in the organization wondered whether a former tax lawyer had the proper grounding in financial services. In fact, she was among the bankers working on several high-profile financial service IPOs before being elevated to CFO.
Many people at Lehman were also dismayed by Callan’s flashy public persona. A glowing profile in the March 2008 issue of Condé Nast Portfolio was titled “Wall Street’s Most Powerful Woman” and pictured Callan emerging from a limo showing a lot of leg. The article by Sheelah Kolhatkar emphasized Callan’s femininity, describing her “short crocheted dress with a black belt slung low around her hips, gold hoop earrings, and knee-high caramel-colored high-heel boots.” Callan didn’t mind the focus. “I don’t subordinate my feminine side,” she told Kolhatkar. “I’m very open about it. I have no problem talking about my [personal] shopper or my outfit.”
Then a May 2008 Wall Street Journal profile of Callan raised eyebrows further and annoyed many people with its centerpiece photo of Callan, looking slinky in an above-the-knee black dress and very high stiletto heels. “She seems to be everywhere modeling her wardrobe,” one insider complained to me. “I wouldn’t mind, but does she know what she’s doing?”
As a woman in the men’s club of finance, I had some sympathy for Callan. Women always faced this kind of scrutiny, and it wasn’t entirely fair. I was more interested in the substance of Callan’s position and contribution.
Callan was an extremely smart woman, and I always found her very knowledgeable. But there was no question that she was on the defensive after Bear went down.
“Is Lehman next?” I asked her.
“Categorically no,” she said without hesitation. “It’s really rumor. I mean, every time the markets are under pressure, Lehman is supposedly hanging on by its fingernails. We fully anticipated that Monday was going to be a very, very difficult day for us, that we would be a top target, and we had a game plan to address it. But how do you get yourself out of that predicament? It just takes time and patience, proving ourselves in a tough environment.”
I pushed back. “I have a hard time understanding how things could change so fast and furiously for Bear. Can your business really reverse course like that in a forty-eight-hour period, or was that perhaps a situation unique to Bear?”
“I think that will be the lingering question about our industry and our business model,” she said carefully, while insisting that Lehman was sound. Callan didn’t want people to start thinking about dominoes falling.
Callan returned to my show on April 1 to respond to reports that Lehman was looking to raise additional capital. “Good to see you a little sooner than expected,” she said, making a sour face. “Unfortunately, we’re in a market where perception trumps reality.” She went on to make the case that Lehman’s efforts in no way showed desperation.
One person who was not impressed with Callan’s explanations was David Einhorn, the young president of Greenlight Capital, who had become a thorn in Lehman’s side. In April he reported that he was shorting Lehman stock, and he started doing frequent television interviews deriding Lehman. Callan was upset. She felt that Einhorn didn’t fully understand Lehman’s position. When Einhorn asked for a conference call, Callan was wary, fearing a setup. But Fuld wanted her to do it, so she went ahead. The call was a disaster. Einhorn publicly disputed her claims and said that he wasn’t impressed by her poorly prepared answers to his questions.
Einhorn made no secret of his belief that Callan was woefully unqualified—and worse, that she was presenting phony numbers, inflating assets, and burying problems. On May 21, Einhorn made a speech at the prestigious Ira W. Sohn Investment Research Conference, which coincided with the publication of his book, Fooling Some of the People All of the Time.
In his speech, which was by turns fiery and sarcastic, Einhorn pointed out that some entities had made investments that they believed would generate smooth returns, but the investments couldn’t deliver. “The dec
line in current market values has forced these institutions to make a tough decision,” he said. “Do they follow the rules, take the write-downs, and suffer the consequences whatever they may be? Or worse, do they take the view that they can’t really value the investments in order to avoid writing them down? Or, even worse, do they claim to follow the accounting rules, but simply lie about the values? The turn of the cycle has created some tough choices. Warren Buffett has said, ‘You don’t know who is swimming naked until the tide goes out.’” And clearly, Einhorn believed, the tide had gone out on Lehman Brothers and exposed plenty. He directed particularly scathing criticism toward Callan. Citing their conference call about quarter two results, he jabbed at her, noting, “Erin Callan used the word ‘great’ fourteen times, ‘challenging’ six times, ‘strong’ twenty-four times, and ‘tough’ once. She used the word ‘incredibly’ eight times. I would use ‘incredible’ in a different way to describe the report.”
But then he went in for the kill. “For the last several weeks, Lehman has been complaining about short-sellers,” he said. “Academic research and our experience indicate that when management teams do that, it is a sign that management is attempting to distract investors from serious problems. I think that there is enough evidence to show how Lehman answered the difficult question as to whether to tell the truth and suffer the consequences or not. This raises the question, though, of what incentive do corporate managers have to fully acknowledge bad news in a truthful fashion?
“For the capital markets to function,” he concluded, “companies need to provide investors with accurate information rather than whatever numbers add up to a smooth return. If there is no penalty for misbehavior—and, in fact, such behavior is rewarded with flattering stories in the mainstream press about how to handle a crisis—we will all bear the negative consequences over time.”
The Weekend That Changed Wall Street Page 6