Too Big to Fail

by Andrew Ross Sorkin

  Kashkari knew the proposal was very complicated but argued it was worth the risk, as the way things were heading, there was little chance of a “soft landing.” Drastic action was required. “The bill would need to give Treasury temporary authorization to buy the securities, as well as the funding,” he said, “and it would need to raise the debt ceiling, because we only have room for about $400 billion under the current ceiling.

  “But because we would be tapping the private sector so heavily, the program would require little in the way of government overhead: no significant hiring by Treasury, for example,” he continued. “But also we need to be mindful of the optics. Only public financial institutions would be eligible. No hedge funds or foreign banks.”

  Then Kashkari summarized what he and his colleagues at Treasury viewed as the pros and cons of their proposal. The first and most important point was that if the government acted, banks would continue lending—but not, it was hoped, in the irresponsible way that gave rise to the crisis in the first place. The primary argument against the proposal was that, to the extent that the plan worked, it would create “moral hazard.” In other words, the people who made the reckless bets that initially caused the problems would be spared any financial pain.

  The two Treasury officials next presented the alternative approaches, of which they had identified four:

  The government sells insurance to banks to protect them from any further drop in the value of their toxic assets.

  The Federal Reserve issues non-recourse loans to banks, as it did in the JP Morgan takeover of Bear Stearns.

  The Federal Housing Authority refinances loans individually.

  Treasury directly invests in the banks.

  As he listened, Bernanke stroked his beard and occasionally offered a knowing smile. The meeting ended with no resolution except to take the plan and put it on the shelf until—or unless—it was needed, but Kashkari was gratified that the chairman took it so well—much better, in fact, than his own boss, Hank Paulson, had when Kashkari first decided to test him on the subject of intervening in the financial markets.

  Everyone in Paulson’s inner circle at Treasury had heard about when Kashkari barged into his office late one evening in March, finding the secretary in an unusually good mood, chatting with his chief of staff, Jim Wilkinson.

  “Hank, I want to talk about bailouts,” Kashkari interrupted.

  “What are you talking about? Get out of here,” Paulson said, annoyed.

  “Look, we keep talking about how do we get the political will to get the authority we need to really take action, right? Well, we have to have some record that shows we tried. The next president is going to come in and say, ‘Here are the steps that should have been taken, but the previous administration was unwilling or unable to take them, blah, blah, blah’ You know what that means? The next president is going to bring the hostages home. Obama! Obama is going to bring the hostages home!”

  Paulson erupted in laughter at the notion that Obama would somehow ride this crisis the way Ronald Reagan rode the Iranian hostage standoff in the late 1970s. He pointed at Kashkari.

  “Ha, ha. Obama is going to bring the hostages home,” Paulson said. “Oh, yeah? Get the fuck out of here.”

  A London sky of gray-pink clouds was just beginning to darken on an evening in April when the phone rang for Bob Diamond, the chief executive of Barclays Capital. Diamond had been contentedly honing his putting skills in his office in the bank’s corporate enclave in Canary Wharf, the booming financial district in East London known as the Square Mile, and a dozen golf balls were strewn about the hole he had cut into the carpet. The office’s walls were lined with Boston Red Sox mementos, which had been hung there not merely to torture visitors from New York City—of which there were many—but because Diamond, a native New Englander, was also a die-hard Sox fan.

  He disliked having his precious few minutes of downtime interrupted, but in this instance he was happy to put down his putter and take the call. It was his friend Bob Steel, whom he had just seen briefly on his recent trip to Washington for the dinner party at the Treasury Building.

  The two had become close after they joined the board of Barclays at the same time in 2005. They came from different parts of the country and different parts of the business—Steel, from Durham, North Carolina, was in Goldman equities; Diamond, from Springfield, Massachusetts, was a former bond trading executive for Morgan Stanley and Credit Suisse. But they recognized similar qualities in each other: Each came from middle-class families and had worked his way through college.

  The arc of their careers more recently had been nearly identical: Both Steel and Diamond, as Yankees in Queen Elizabeth’s court, had made quite a splash in London. For Steel, success had come with starting Goldman’s European equities trading operation, a feat Hank Paulson, his former boss, always remembered. For his part, Diamond had transformed a small investment bank with some 3,000 employees into a major London powerhouse that currently had a payroll of 15,000. Barclays Capital now accounted for about a quarter of the bank’s profits.

  The two had remained friends after Steel quit the Barclays board to follow Paulson to Treasury, to the point that each had always been able to count on the other to pick up the phone if he called, whatever the reason.

  “Listen, one of my jobs here is to brainstorm,” Steel said somewhat stiffly after greeting Diamond, “and, ah, sort of sketch out various scenario plans. In that capacity, I have a question for you.”

  Steel’s uncharacteristically distant tone surprised Diamond, who asked, “Is this official business, Bob?”

  “No, no. Look, I’m not calling on behalf of anyone,” he assured him. “The markets have calmed down a bit now, but I am trying to figure out that if things do get worse, and we get to a certain level, if, ah, things can happen.”

  “All right, shoot.”

  Steel took a deep breath and then asked his question: “Is there a price at which you’d be interested in Lehman? And if so, what would you need from us?”

  Diamond was momentarily speechless; Treasury, he realized, was clearly trying to formulate strategic solutions in the event that Lehman found itself in a Bear Stearns–like situation. From long acquaintance he knew Steel to be a no-nonsense pragmatist, not someone who idly floated trial balloons.

  “I’m going to have to think about that because I don’t have an answer,” Diamond said carefully.

  “Yes, but do think about it,” Steel said.

  “Never say never,” Diamond answered, and both men laughed. Diamond had always trotted out that line when reporters pressed him about possible acquisitions, though this was the first time that Steel had been on the receiving end of it.

  Steel was well aware of Barclays Capital’s desire to increase its presence in the United States, an ambition that Diamond practically wore on the sleeve of his Saville Row suits. While he had built, from the ground up, a major investment bank that had been a London phenomenon, he had always yearned to be a major player on Wall Street. His restless pursuit of that goal explained why Diamond had so abruptly left Morgan Stanley for Credit Suisse First Boston in 1992, taking much of the repo trading desk with him and inciting the wrath of John Mack. Four years later, Diamond left for BZW, whose remnants were the foundation for Barclays Capital.

  Lehman was a logical merger candidate if Diamond—and, of course, his boss and the board in London—wanted Barclays to become an overnight investment banking powerhouse in New York. But he knew it would be an expensive purchase so long as Dick Fuld was running it. Still, an opportunity like this hardly came up often.

  What the rest of Wall Street didn’t know at the time was that Barclays had been contemplating another purchase: Diamond had been in conversation with UBS about buying its investment banking franchise and was planning to fly to Zurich later that week for further meetings. He now shared this information with Steel but cautioned him that the talks with UBS were very preliminary, and the last thing Diamond needed was word of them le
aking out. As was always a possibility, the deal might not go anywhere.

  Lehman, in any case, was in a different league altogether. It wouldn’t be easy selling an acquisition of this magnitude to his board, who were still feeling gun shy after losing an expensive bidding war for Dutch bank ABN AMRO months earlier. But Lehman was the fourth biggest investment house in the United States. If Lehman could be had for a major discount, he’d have to consider the prospect seriously, wouldn’t he?

  “Yes,” Diamond said to Steel, “it’s definitely something to think about.”

  CHAPTER FIVE

  Surprisingly soft-spoken when not on the air, Jim Cramer, CNBC’s blustery market guru, politely told the security guard standing outside Lehman Brothers’ headquarters on Seventh Avenue and Fiftieth Street that he was expected for a breakfast meeting with Dick Fuld. He was ushered through the revolving door, past Lehman’s bomb-sniffing Labrador, Bella, and to the reception desk, where he made his way through the familiar security procedures. Looking rumpled as usual, he was received in the waiting area of the thirty-second floor as ceremoniously as if he were a major client who had arrived to negotiate a billion-dollar deal. Erin Callan, the CFO, was present, as was Gerald Donini, the head of global equities and a neighbor of Cramer’s in Summit, New Jersey.

  Fuld, who was still zealously conducting his jihad against the short-sellers, had personally invited Cramer for the meeting. By now he had come to realize that he needed an ally in his struggle against the shorts, but so far, nobody had been willing to join the battle. Not Cox. Not Geithner. And not Paulson, despite their recent conversation at Treasury. But maybe Cramer, with his huge television audience and connections deep within the hedge fund world, could somehow help sway the debate and talk up Lehman’s stock price.

  Fuld had known Cramer for a decade. After Long-Term Capital Management blew up in 1998, word spread that Lehman had huge exposure to the fund and might be the next to go down. Fuld had received a major public boost from Cramer, then a new face at CNBC, when he declared on television that all Lehman needed to do was buy back its own shares to halt the downward spiral and squeeze the shorts. The following morning, Fuld, who had never met Cramer, called him at his office and told him, “I bid thirty-one dollars for one million shares of Lehman.” Shares of the company steadied soon afterward.

  If Wall Street had indeed been taking on some aspects of a Shakespearean tragedy, Cramer would likely serve as the comic relief. Voluble and wild-eyed, he spoke in his TV appearances so quickly that it often seemed as if his head might explode from the sheer effort of communicating his ideas. But for all his carnival-barker antics, people on Wall Street knew Cramer was no fool. He had managed a hedge fund and founded TheStreet.com, an early and influential investing Web site, and had a keen understanding of how the market worked.

  Fuld and Cramer had come to respect each other as no-nonsense street fighters, despite their pronounced differences in character. Cramer, a media star, was solidly Harvard, had once worked at Goldman, and counted as one of his best friends Eliot Spitzer, the bane of Wall Street. Fuld, for his part, tended to despise Ivy Leaguers, liked to think of himself as the anti-Goldman, and had never been much of a communicator. Still, he appreciated the fact that Cramer had always been an honest broker, willing to speak his mind, however unpopular his opinions might be.

  After one of Lehman’s wait staff had taken food orders, for the group, Fuld walked an attentive Cramer through his talking points. Lehman, Fuld said, was working hard to reduce the firm’s leverage and restore confidence among investors. Though they had raised $4 billion in new capital in the first quarter, Fuld was convinced that a “cabal of shorts” was preventing the stock price from being properly reflected. The franchise was undervalued.

  Cramer nodded his head energetically. “Look,” he said, “I think there is definitely a problem with the shorts—they’re leaning all over you.”

  Fuld was gratified to see that he had a receptive audience. As he was well aware, his short-seller predicament touched on an obscure issue near and dear to Cramer: the uptick rule—regulation that had been introduced by the Securities and Exchange Commission in 1938 to prevent investors from continually shorting a stock that was falling. (In other words, before a stock could be shorted, the price had to rise, indicating that there were active buyers for it in the market. Theoretically, the rule would prevent stocks from spiraling straight downward, with short-sellers jumping on for the ride.) But in 2007 the commission had abolished the rule, and to critics like Cramer, its decision had been influenced by free-market ideologues who were eager to remove even the most benign speed bumps from the system. Ever since, Cramer had been warning anyone who’d listen that without this check, hedge funds were free to blitzkrieg good companies and drive down their stock.

  But until the current crisis, few had been willing to listen to his admonitions. Because their hedge fund clients wanted the rule eliminated, Wall Street firms were happy to accede—right up until the time that they themselves became the target of short-sellers and had to run for cover.

  “You can be a great ally to me on this uptick rule crusade,” Cramer said.”

  Fuld contemplated his guest’s enthusiasm as he silently weighed the advantages and disadvantages of lending his firm’s name to the cable news star’s crusade. Cramer was probably right about the rule’s removal hurting Lehman, but Fuld also knew that his firm’s own arbitrage desk had hedge fund clients who were selling short, and they made the firm a great deal of money. He certainly didn’t want to alienate them, and at the same time, he recognized that there was a legitimate debate about the issue. And however protective the restrictions may have been intended to be, Fuld knew perfectly well that investors could get around them by using options and derivatives.

  Donini, skeptical that the uptick rule was Lehman’s biggest problem, interjected on behalf of Fuld. “What are you trying to accomplish, Jim?” he asked.

  “The shorts are destroying great companies,” Cramer replied. “They destroyed Bear Stearns, and they’re trying to destroy Lehman,” he said, perhaps trying to play to Fuld’s ego. “I want to stop that.”

  “If you’re trying to accomplish that,” Donini replied, “and you believe that shorts are causing the problem, then I don’t believe the uptick rule is the way to do it.” Donini explained to Cramer that he felt the real problem in the marketplace was “naked shorting.” Normally, when investors sell shares short, the investor first borrows the shares from a broker, sells them, and then hopes they drop in value so the investor can buy them at a lower price, replace the borrowed shares, and pocket the difference as a profit. But in naked shorting—which is illegal—the investor never borrows the underlying shares, potentially allowing them to manipulate the market.

  Cramer was intrigued but also visibly taken aback by Donini’s answer. He had been invited to the meeting, had offered to help, and now his offer was being rejected. He tried changing the subject back to Lehman’s troubles. “Well, why don’t you give me ammo so that I can tell a positive story?” he suggested.

  Sensing the tension rising in the room, Callan interjected, speaking up for the first time. “We just bought this unbelievable portfolio from Peloton, and it’s immediately accretive,” she said, cheerfully offering what she considered a bit of good news.

  But Cramer could barely conceal a frown, for he knew a good deal about Peloton. Based in London, the hedge fund had been started by Ron Beller, a former Goldman executive whose wife was a policy adviser to Prime Minister Gordon Brown. It had once been among the top-performing hedge funds in the world but had faltered, selling its assets in a virtual fire sale. “Geez,” Cramer answered with as much tact as he could muster, “I’m surprised to hear it’s any good, given the fact that they were levered thirty to one with what I hear is a lot of bad stuff.”

  “No,” Fuld said enthusiastically, “we got this for a song.”

  Cramer did not look convinced. “One of the things I’m really unclear ab
out is that, if you talk to Goldman, Goldman’s radically trying to deleverage, and what you’re saying is, ‘I’m gonna deleverage,’ but you actually are increasing your leverage.”

  Fuld, who didn’t appreciate the tone of the observation, responded, “What we’re doing is, we’re buying really important portfolios that we think are worth a lot more and we’re trading out of ones that are worth less.”

  Callan said that Lehman was quickly deleveraging its own balance sheet. She also said, “There are assets on the books that we have a high degree of confidence are undervalued.” She spent the next ten minutes telling Cramer about the firm’s residential real estate assets in California and Florida, two of the hardest hit markets, suggesting she expected them to rebound soon.

  Having come to the conclusion that any alliance with Cramer could only be problematic, Fuld quickly changed the subject and began pumping Cramer for information. “So, what are you hearing out there? Who’s coming after us?”

  Fuld said that he had become convinced that two of the nation’s most powerful financiers, Steven A. Cohen at SAC Capital Advisors in Greenwich, Connecticut, and Kenneth C. Griffin of Citadel Investment Group in Chicago, were largely responsible for both the short raid and rumormongering, though he didn’t say their names aloud.

  “They are liars!” Fuld said adamantly of the shorts. “I think it’s pretty safe for you to go out and say they’re liars.”

  Cramer, while sympathetic, made it clear that he wasn’t prepared to go out on a limb and back Lehman’s stock unless he had more information. “I can say that people could be skeptical of the rumors,” he offered, and then added, “why don’t you go to government? If you think this is so bad and you think that there’s a real bear raid and people are lying about it, why don’t you go tell the SEC?”

  But Fuld, growing increasingly agitated, only repeated, “Why don’t you just give me the names of people telling you negative things about us?”