Too Big to Fail

by Andrew Ross Sorkin

  When Fuld returned to the living room, he unexpectedly broke into the conversation, saying, “You know, with all these rumors going around about Lehman, I would hope that you won’t try to poach any of my people.”

  The Morgan Stanley executives were taken aback.

  Chammah, a Lebanese-born banker who spent most of his time running Morgan’s operations form London, retorted: “If you recall, you weren’t shy about building your European operation off of our talent.”

  The meeting ended with no agreement and what seemed like no incentive to keep talking.

  “What the fuck was that all about?” Mack asked after the Lehman executives departed. “Was he offering to merge with us?”

  “This is delusional,” Gorman said. Taubman had other worries. Maybe they were being used to help Lehman goose its stock price? “We’re playing with fire here,” he warned them. “If I were their guys, I’d want to put my own spin on this.”

  Fuld, discouraged but undeterred, drove from Mack’s house to Lehman’s headquarters in Manhattan, racing down the Henry Hudson Parkway. He had scheduled a call with Tim Geithner for that Saturday afternoon. His outside lawyer, Rodgin Cohen, chairman of Sullivan & Cromwell, had recently suggested a new idea to help stabilize the firm: to voluntarily turn itself into a bank holding company. The move, Cohen had explained to Fuld, “would give Lehman access to the discount window indefinitely, just like Citigroup or JP Morgan have.” That, in turn, could take some of the pressure off investors worried about the firm’s future. It would also mean that Lehman would become regulated by the Federal Reserve of New York, which would have to sign off on the plan.

  Cohen, a sixty-four-year-old mild-mannered mandarin from West Virginia, was one of the most influential and yet least well-known people on Wall Street. While soft-spoken and small in physical stature, he had the ear of virtually all the banking CEOs and regulators in the country, having been involved in nearly every major banking transaction of the last three decades. Geithner often relied on him to understand the Federal Reserve’s own powers.

  For the past several months, Cohen had been speaking with Fuld almost daily, trying to help him formulate a plan. He was very familiar with bank failures and wanted to make sure Lehman would not become one of them. Cohen had spent many days in the summer of 1984 in a hot, windowless room in Chicago, trying to work out a rescue of Continental Illinois National Bank and Trust. “We have a new kind of bank,” Stewart McKinney, U.S. representative from Connecticut, announced that year. “It is called ‘too big to fail.’ TBTF, and it is a wonderful bank.” The $4.5 billion government rescue plan that emerged was shaped in large part by Cohen. Cohen, who had also advised the board of Bear Stearns in its takeover by JP Morgan, had organized the call with Geithner’s office.

  Pacing back and forth in his hotel room in Philadelphia before the wedding of his niece that night, Cohen joined the call between Lehman and the Federal Reserve of New York.

  “We’re giving serious consideration to becoming a bank holding company,” Fuld started out by saying. “We think it would put us in a much better place.” He suggested that Lehman could use a small industrial bank it owned in Utah to take deposits to comply with the necessary regulations.

  Geithner, who was joined on the call by his general counsel, Tom Baxter, was apprehensive that Fuld might be moving too hastily. “Have you considered all the implications?” he asked.

  Baxter, who had cut short a trip to Martha’s Vineyard to participate, walked through some of the requirements, which would transform Lehman’s aggressive culture, minimizing risk and making it a more staid institution, in league with traditional banks.

  Regardless of the technical issues that would have to be faced, Geithner said, “I’m a little worried you could be seen as acting in desperation,” and the signal that Lehman would send to the markets with such a move.

  Fuld ended his call deflated. He had worked his way through a checklist of every alternative he could think of, and nothing was sticking. He and McDade had even begun working up a plan to consider shrinking Lehman Brothers into a hedge fund with a boutique bank attached and trying to take the firm private, outside the glare of public investors. But he’d need to raise cash from someone even to do that.

  Later that evening, Fuld called Cohen, finding his lawyer in the waiting room of a hospital, attending to a cousin who had become ill at the wedding. It was time to consider a different kind of deal, he told Cohen. “Can you reach out to Bank of America?”

  Selling Lehman had always been anathema to Fuld—“As long as I am alive this firm will never be sold,” he had said proudly in 2007. “And if it is sold after I die, I will reach back from the grave and prevent it.” He had, however, longed to make a big acquisition. For a brief moment he came close to buying Lazard—so close that he had even settled on calling the firm Lehman Lazard—a purchase that might have been his crowning achievement, turning his scrappy bond-trading operation into a white-shoe firm with a global reputation. Fuld had held a meeting in his then-office at the World Financial Center on September 10, 2001, with William R. Loomis and Steve Golub of Lazard. They left the meeting with plans to continue their discussions. Then, of course, came 9/11.

  Bruce Wasserstein, who later took over Lazard, tried to resurrect the discussions, but Fuld became so outraged by the price Wasserstein said he wanted—$6 billion to $7 billion—that their conversation quickly devolved.

  “Clearly we don’t see value the same way,” Fuld derisively told him. To Fuld, Wasserstein, who had been branded “Bid-em up Bruce,” had just lived up to his name. “There’s just no way I could pay that.”

  Still standing in the emergency waiting room of the hospital, Rodgin Cohen found Greg Curl, Bank of America’s top deal banker, on his cell phone in Charlotte, where the bank was based. Curl, a sixty-year-old former naval intelligence officer who drives a pickup truck, had always been a bit of an enigma to Wall Street. He had helped orchestrate nearly every deal Bank of America had made over the past decade, but even within the bank he kept to himself and was generally considered a tough read.

  Cohen, who had dealt with Curl over the years but had never been able to take an accurate assessment of him, treaded carefully, explaining that he was calling on behalf of Lehman Brothers.

  “Do you have any interest in doing a deal? Of all the institutions we’ve been considering, you’d be the best fit,” Cohen said, promising that he could get Fuld on the phone if Curl was curious enough to have a conversation.

  Curl, though intrigued to be getting a call on a Saturday night, was noncommittal; he could tell they must be desperate. “Hmm…let me talk to the boss,” he said. “I’ll call you right back.”

  The boss was Ken Lewis, the silver-haired CEO of Bank of America, a hard-charging banker from Walnut Grove, Mississippi, who was on a mission to beat Wall Street at its own game. (When he was a child, two boys once ganged up on him; his mother, catching sight of the scrap, came out of the house and said, “Okay, you can fight him, but you’re going to have to do it one at a time.”)

  A half hour later, Curl called back to say he’d hear them out, and Cohen set up a three-way call with Fuld through the switchboard at Sullivan & Cromwell.

  After some brief introductions—the men had never met before—Fuld began with his pitch.

  “We can be your investment banking arm,” Fuld explained, the idea being for Bank of America to take a minority position in Lehman Brothers and for the two to merge their investment banking groups. He invited Curl to meet with him in person to discuss the proposal further.

  Curl, sufficiently intrigued, said he would fly up from Charlotte to New York on Sunday. While Fuld thought it odd that he wasn’t negotiating directly with Ken Lewis, there was a compelling reason for Curl to travel alone: Lewis could legitimately deny that he had ever spoken with Fuld, should the discussion leak.

  Before signing off, Curl made certain to underscore his greatest anxiety: “We want to be absolutely sure this is conf
idential.”

  At midmorning on Sunday, David Nason and Kevin Fromer were sitting on the couch in Nason’s office at Treasury, going over a draft of the proposal to petition Congress for the authority to inject money into Fannie and Freddie in the case of an emergency. The office was littered with sandwich wrappers and bags from nearby Corner Bakery Café. Most of the staff had been working since early Saturday morning and had gone home only to grab a few hours of sleep. The proposal had to be ready by 7:00 p.m.

  Suddenly, Paulson walked into the office with a look of horror on his face and, holding up a page of the draft, bellowed, “What the fuck is this?” “‘Emergency authority on a temporary basis?’ Temporary?” he said, almost shouting. “We are not going to ask for temporary authority!”

  The draft provided for emergency authority for a period of eighteen months, the rationale for which Fromer, who was Treasury’s liaison to lawmakers, leaned forward and attempted to explain. “Look, you can’t ask Congress for permanent—”

  Paulson rarely allowed himself to show his anger, but he now made no attempt to restrain it as he paced the room.

  “First of all, this is my judgment to make, not yours,” he said. “Secondly, this is a half-measure. I am not leaving my successor with the same shit that I’ve got. We are going to fix these problems. I am not pushing this crap down the road.”

  Nason’s cell phone rang. “Tim!” he shouted, checking the caller ID, before realizing he was interrupting Paulson’s soliloquy. Tim Geithner had been calling for updates nearly every hour.

  Nason and Fromer tried again to calm Paulson down. They reiterated that it would be much more palatable politically to say that they were asking for temporary powers rather than permanent ones. And, as Fromer told him, “It’s a distinction without a difference,” explaining that during the period they had the authority, they could still make decisions that would be permanent.

  Paulson, starting to recognize the value of the political calculus, relented. He told them to keep working on it and walked out as abruptly as he’d walked in.

  Greg Curl, dressed in a blazer and slacks, arrived at Sullivan & Cromwell’s Midtown offices in the Seagram Building on Sunday afternoon, having flown up to New York from Charlotte that morning on one of the firm’s five private jets.

  Taking a seat in the empty reception area, he waited for Fuld and Cohen to appear, uncertain about how fruitful the meeting could possibly be. While “The Boss” may have wanted to conquer the commercial banking world, he had an aversion to the fast-money investment banking business. “No, we wouldn’t use our petty cash to buy an investment bank,” he’d dryly said just a month earlier. Almost a year before, his own investment banking business, long considered an also-ran, showed a stunning 93 percent plunge in profit in its third quarter. At the time, Lewis had remarked that he “had had about all the fun he could stand in investment banking right now.”

  Curl was soon escorted to a conference room, where he paid careful attention as Fuld walked him though his idea in greater detail. He wanted to sell a stake of up to a third of Lehman Brothers to Bank of America and merge their investment banking operations under the Lehman umbrella.

  As Curl listened, he was dumbfounded, though characteristically gave no sign of what he was thinking. Far from the plea for help he had been expecting, the pitch he was hearing struck him as a reverse takeover: Bank of America would be paying Fuld to run its investment banking franchise for it.

  Fuld also suggested that any investment would “boost our stock price” overnight, creating even more value for Bank of America. He rationalized that buying a stake in Lehman—as opposed to buying the entire firm—would provide incentive for the firm’s savvy bankers to stay in their jobs. “You’re not going to be able to keep these people if they can’t see a financial upside,” he argued, making a relevant point about most full-bank mergers—namely, that the talent usually cashes out and leaves.

  Curl nodded appreciatively throughout the presentation, before finally stating that the boss—Lewis—would be interested in entertaining the prospect of a deal only if he had a clear path to taking control of the firm in a reasonable amount of time.

  Cohen, interjecting on behalf of Fuld, suggested that they should think about a time frame of two to three years, depending on how successful the investment was.

  That was more along the lines of what Curl wanted to hear. He told them he was intrigued, but that he and Lewis had often disagreed about whether they should acquire an investment bank or continue buying up other commercial banks. “I don’t like the retail business,” Curl confided, “because of the susceptibility of litigation and attorneys general and regulators.

  “I’d prefer a deal with you,” he continued, “but to be honest, Ken would probably prefer to buy Merrill or Morgan.”

  Fuld was confused. What was Curl signaling?

  “So do you think we have something here?” Fuld asked.

  “I don’t know,” Curl said. “I need to talk to the boss. It’s obviously his decision.”

  By late afternoon, Paulson, unshaven and wearing jeans, was pacing the halls and pestering his staff with so many questions about the Fannie and Freddie proposal that his chief of staff, Jim Wilkinson, finally took him aside and said forcefully, “You’ve got to get out of our hair and let us do our jobs.”

  To blow off steam, Paulson decided to take a quick bike ride around the near-empty Washington streets. He couldn’t stop thinking about the plan and what it might mean to his legacy: He, a Republican, a man of the markets, was going to ask for authority to invest U.S. taxpayer money in the two institutions that were perhaps most responsible for the housing boom and bust. On the other hand, after decades of political infighting over these two entities, he would have the opportunity to undo them. But would he actually need to use the authority that he was asking for? Would simply having the authority be enough to calm the markets? As he pedaled his bike, he hoped that would be the case.

  When Paulson returned, Michele Davis, his communications chief, was trying to figure out where he could physically announce the proposal. “We can’t have reporters and camera crews in the building,” she said. “We could have you go outside on the steps.” Nason, walking over to a window, warned that the forecast called for a thunderstorm.

  “I don’t know what to do,” she said, trying to figure out if they had a podium they could bring outdoors. “But you have to go home and change clothes,” she told Paulson, pointing at his rumpled jeans. “You can’t go out there like that.”

  At 6:00 p.m., cleanly shaven and now dressed in a blue suit, Paulson walked out onto the Treasury’s steps to a podium that had been hauled downstairs from the fourth floor and addressed the swarm of reporters who had assembled hastily.

  “Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies,” Paulson said, reading a statement. “Their support for the housing market is particularly important as we work through the current housing correction.

  “GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure.

  “To ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed.”

  Minutes after he finished, thunder rumbled in the distance. Soon the skies opened up.

  Paulson could tell the hearing on Tuesday morning was going to be hostile the moment he took his seat to the right of Bernanke and Cox. His announcement on the Treasury steps had done little to shore up confidence. In fact, it seemed to be undermining it even further, creating confusion in the marketplace about what this new “authority” he was seeking really meant. Freddie ended down 8.3 p
ercent, to $7.11, while Fannie lost 5 percent, falling to $9.73 on Monday. He knew he needed to start spinning fast, as much for Congress as for the markets.

  “Our proposal,” he explained to the Senate Banking Committee, “was not prompted by any sudden deterioration in conditions at Fannie Mae or Freddie Mac…. At the same time, recent developments convinced policy makers and GSEs that steps are needed to respond to market concerns and increase confidence by providing assurances of access to liquidity and capital on a temporary basis if necessary.”

  As he was barraged with questions, Paulson emphasized the “temporary” nature of the authority he was seeking, hoping to win over the congressmen. “It is very intuitive,” he said, “that if you’ve got a squirt gun in your pocket, you may have to take it out. If you have got a bazooka, and people know you’ve got it, you may not have to take it out.”

  Some panel members, however, were not buying that justification.

  “When I picked up my newspaper yesterday, I thought I woke up in France,” said Senator Jim Bunning, the Kentucky Republican. “But no, it turned out it was socialism here in the United States of America. The Treasury secretary is now asking for a blank check to buy as much Fannie and Freddie debt or equity as he wants. The Fed purchase of Bear Stearns’ assets was amateur socialism compared to this…. Given what the Fed and Treasury did with Bear Stearns, and given what we are talking about here today, I have to wonder what the next government intervention into the private enterprise will be? More importantly, where does it all stop?”

  Clearly frustrated by what he was hearing, Paulson struggled to articulate his defense. “I think our idea is that, that by having the government provide an unspecified backstop, the odds are very low that it will be used and the cost to the taxpayers will be minimized.”