Too Big to Fail

by Andrew Ross Sorkin

  “Do you think we can believe exactly what you’re saying, Secretary Paulson?” Bunning replied patronizingly.

  “I believe everything I say and that I’ve been around markets for a long time—” Paulson began to reply before Bunning cut him off.

  “Where is the money going to come from if you have to put it up?” Bunning asked.

  “Well, obviously, it will come from the government, but I would say—”

  “Who is the government?” Bunning asked indignantly.

  “The taxpayer,” Paulson acknowledged.

  “Secretary Paulson, I know you’re very sincere in your proposal,” Bunning continued. “But come January, you will be gone, and the rest of us will be sitting at these tables—or at least most of us—and we all have to be responsible to the taxpayer for what we have done.”

  A socialist. Mr. Bailout. Hank Paulson believed he was fighting the good fight, a critical fight to save the economic system, but for his efforts he was being branded as little less than an enemy of the people, if not an enemy to the American way of life. He couldn’t understand why no one could see how bad the situation had really become. That afternoon another faction had joined the group of antagonists: The hedge funds were furious with him for having convinced Christopher Cox at the SEC to begin cracking down on improper short selling in the shares of Fannie and Freddie, as well as seventeen other financial firms, including Lehman.

  With Bob Steel gone, he felt he had been left on his own to confront the biggest challenge of his tenure. He valued his staff, whom he regarded as a remarkably intelligent group, but questioned whether he had enough firepower to wage what he could see was quickly becoming a heated war. That afternoon he left a message for Dan Jester, a forty-three-year-old retired Goldman Sachs banker who had been the firm’s deputy CFO and was now living in Austin, Texas, managing money, mostly his own. Paulson had depended heavily on Jester, a long-haired “human calculator,” when he was the firm’s CEO, and he hoped he might be able to convince Jester to come out of retirement to help him work on the GSEs.

  The night before, feeling somewhat desperate, he had also placed a call from home to Ken Wilson, an old friend from Dartmouth whom he had persuaded to leave Lazard for Goldman a decade earlier. As head of the financial institutions group, Wilson was Goldman’s top adviser to other banks and respected as an éminence grise throughout the industry. Paulson so respected his judgment that he had put Wilson in an office near his own on the thirtieth floor of 85 Broad Street.

  “Ken, I really need help around here. I need some adults,” Paulson said when he reached him. “Bob Steel is gone. I’d like you to think about coming down here and joining my team.” Wilson, Paulson proposed, would be a “classic dollar-a-year man,” meaning that he would come on board as a “special adviser” for the nominal salary of $1 for the final six months of the administration. He suggested that Wilson take a leave from Goldman.

  Wilson, who at sixty-one had already been considering retiring from the firm, said that he would think about it.

  “I could use your help,” Paulson repeated earnestly. “I have lots of issues, um, lots of problems.”

  Given all the gyrations in Lehman’s stock price and the nonstop rumors about its long-term viability, Fuld had scheduled a board meeting in July to update the firm’s directors on the progress he had been making on both fronts.

  Lehman’s board was a strange mix of both the financially sophisticated and the truly naive; most had been old friends of Fuld’s or had been clients of the firm. They included Roger S. Berlind, a seventy-five-year-old theater producer, and Marsha Johnson Evans, sixty-one, a former navy rear admiral and head of the Red Cross; until two years earlier, the eighty-three-year-old actress and socialite Dina Merrill had also been a member. Among the more experienced were Henry Kaufman, then eighty-one, who was a former chief economist at Salomon Brothers; John Akers, a former chief executive of IBM; and Sir Christopher Gent, sixty, former head of Vodafone PLC. Of the ten outside directors, four were over seventy-four years old.

  For this meeting, Fuld had invited a guest to give a presentation. Gary Parr, a banker at Lazard, had been speaking with Fuld recently and suggested he could try to help the board if the directors needed independent advice.

  The spindly, bearded Parr was one of the most prominent of the bankers specializing in the financial services industry, having worked on many of the capital-raising efforts that companies like Morgan Stanley and Citigroup pursued in late 2007. Fuld may not have trusted Parr’s boss, Bruce Wasserstein, but he respected Parr.

  Parr was asked by one of the directors to offer some perspective on how bad the market really was. An assured speaker, Parr launched into his regular skeptical boardroom speech.

  “It’s tough out there,” he said forebodingly. “Having been through Bear Stearns and MBIA”—two former clients—“there are some lessons we’ve learned.” Trying to make certain that Lehman’s directors understood the gravity of the situation they were facing, he told them, “Liquidity can change faster than you can imagine,” suggesting they should not think Bear Stearns was a once-in-a-lifetime event. “Rating agencies are dangerous,” he went on. “Wherever you think you stand with the rating agencies, it’s worse…. And let me tell you, it’s difficult to raise money in this environment because asset prices are hard for outside investors to under—”

  “Okay, Gary,” Fuld said, impatiently cutting him off in midsentence. “That’s enough.”

  An awkward silence fell over the room for a moment. Some directors thought Fuld had become upset with the negative direction Parr had taken; others believed that he had rightly quieted him for shamelessly plugging his services. Within ten minutes, Parr slunk out of the room.

  An hour later, back in his office at Lazard in Rockefeller Center, Parr was informed by his secretary that Dick Fuld was on the phone.

  “Goddamit, Gary!” Fuld screamed when Parr picked up the receiver, half-expecting an apology. “What the hell are you doing trying to scare my board and advertising yourself to them like that? I should fire you!”

  For a moment Parr didn’t respond. Frustrated that Lehman hadn’t yet signed an engagement letter, Parr snidely fired back, “Dick, that might be difficult because you haven’t hired us yet.” Then, collecting himself, he said, “I’m sorry. I didn’t mean to go down a path you didn’t want me to go.”

  “You’ll never do that again,” Fuld said, and the phone went dead.

  The next day, Fuld—perhaps fearing that he was beginning to become unwound—realized that berating Parr had been a mistake; the stress was beginning to get to him. In his mind he had cut off Parr for running an advertisement for Lazard, not for suggesting the firm was imperiled. But the damage had been done. He called Parr back, hoping to mend the relationship and to invite him for another meeting.

  “Have you recovered from the phone call?” Fuld asked contritely.

  Ken Wilson was standing in line at Westchester County Airport at 6:45 on the morning of Thursday, July 17, on his way to Montana to start a vacation and do some fly-fishing, when his cell phone rang.

  “Kenny, we really need you,” President Bush told him. “It’s time for you to do something for your country.” Wilson and the president knew each other from Harvard Business School, but Wilson knew this call had not been the president’s idea. This was classic Paulson; he must be really hurting. If Paulson wanted something, he would keep going until he got it, even if it meant enlisting the highest authorities.

  That weekend, Wilson, after talking it over with his colleagues at Goldman, called Paulson. “I’ll do it.”

  On the evening of July 21, Paulson arrived for a dinner in his honor at the New York Fed, organized by Tim Geithner as an opportunity for the secretary to get together with Wall Street leaders—Jamie Dimon, Lloyd Blankfein, and John Mack among them.

  The dinner would be the second gathering of Wall Street heavyweights he’d attended that day. He had earlier been to a private luncheon in
his honor at the offices of Eric Mindich, a former protégé at Goldman Sachs who now ran a hedge fund called Eton Park Capital, where he pressed his case for the pending GSE legislation. Paulson was feeling slightly better about the overall situation, as both Wilson and Jester had agreed to join Treasury, and the prospects for the legislation’s passing were improving. And as he mingled among his former colleagues, he congratulated John Thain of Merrill, who days earlier had sold the firm’s stake in Bloomberg for $4.5 billion.

  What still had Paulson worried, however, was Lehman, and particularly a secret meeting that had been scheduled for after the dinner: He and Geithner had helped orchestrate a private meeting between Dick Fuld and the boss, Ken Lewis, in a conference room at the NY Fed. Fuld had been ringing Paulson for the past two weeks about Bank of America, trying to get Paulson to make a call on behalf of Lehman.

  “I think it’s a hard sell, but I think the only way you’re going to do it is go to him directly,” Paulson had told Fuld. “I’m not going to call Ken Lewis and tell him to buy Lehman Brothers.”

  As the dinner was ending, Paulson walked over to Lewis and said affably, “Those were some good earnings,” reaching out to clasp Lewis’s hand and giving him a knowing look about the upcoming meeting. Although earlier that day Bank of America had reported a 41 percent slide in second-quarter earnings, the results were far better than what Wall Street analysts had expected. That positive surprise followed a series of stronger-than-expected earnings from Citigroup, JP Morgan Chase, and Wells Fargo, all of which were at least temporarily buoying the market.

  When Paulson turned to leave and other executives started to get up and mill around, Geithner approached Lewis and, leaning close to him, whispered, “I believe you have a meeting with Dick.”

  “Yeah, I do,” Lewis replied.

  Geithner gave him directions to a side room where they could speak in private. Geithner had apparently already given Fuld the same instructions, because Lewis noticed him across the room looking back at them like a nervous date. Seeing Fuld start to walk in one direction, Lewis headed in the other; with half of Wall Street looking on, the last thing either of them needed was to have word of their meeting get out.

  The two men eventually doubled back and found the room, but when Lewis arrived, Fuld was in the midst of a heated argument with a Fed staff member. It was only the second time the men had ever met, and the sharp tone of his hectoring startled Lewis.

  For about twenty minutes Fuld explained how he pictured a deal might work, reiterating the proposal he had made to Curl a week earlier. Fuld said he’d want at least $25 a share; Lehman’s shares had closed that day at $18.32. Lewis thought the number was far too high and couldn’t see the strategic rationale. Unless he could buy the firm for next to nothing, the deal wasn’t worth it to him. But he held his tongue.

  Two days later, Lewis called Fuld back.

  “I don’t think this is going to work for us,” Lewis said as diplomatically as he could, while leaving open the possibility that they could discuss the matter again.

  Fuld was beside himself as he called Paulson at 12:35 p.m. to relay the bad news. Now all he was left with was the possibility of the Koreans, and he pressed Paulson to make a call to them on his behalf—a request that Paulson, having already interceded with Buffett and Bank of America, was now resisting.

  “I’m not going to pick up the phone and call the Koreans,” Paulson told him. “If you want to scare someone, call them up and tell them I said they should buy Lehman Brothers,” he said, explaining that his involvement would only heighten suspicion about the firm’s prospects. “Dick, if they call me and want to ask questions, I’ll do what I can to be constructive.”

  It was just the latest bad piece of news of a very long day. That night, Bart McDade forwarded Fuld an e-mail from a trader with more speculation about where the negative rumors were coming from. “It is clear that GS [Goldman Sachs] is driving the bus on the hedge funds kabal [sic] and greatly influencing the downside momentum, LEH and others. Thought it was worth passing on.”

  Fuld replied: “Should we be too surprised? Remember this, though—I will.”

  CHAPTER ELEVEN

  Robert Willumstad could feel the perspiration begin to soak through his undershirt as he strode along Pearl Street at 9:15 a.m. on Tuesday, July 29, in Manhattan’s financial district. Although the humidity was oppressive that summer morning, he was also anxious about his upcoming appointment with Tim Geithner at the Federal Reserve Bank of New York.

  Since accepting the position of CEO at AIG just over a month earlier, he had been working long hours to try to get a handle on the company’s myriad problems. With the exception of a weekend trip to Vail over July Fourth to visit his daughter, he had been at the office seven days a week. When he began the job he had announced plans “to conduct a thorough strategic and operational review of AIG’s businesses” and “to complete the process in the next sixty to ninety days and to hold an in-depth investor meeting shortly after Labor Day to lay it all out for you.”

  As Willumstad started his investigation, his head of strategy, Brian T. Schreiber, pulled him aside and shared a startling discovery he had made: “It could actually be a liquidity problem, not a capital problem.” In other words, even though this massive insurance conglomerate had hundreds of billions of dollars worth of securities and collateral, given the credit crisis, it could find itself struggling to sell them fast enough or at high enough prices to meet its obligations. The situation could become even worse if one of the ratings agencies, like Moody’s or Standard & Poor’s, were to downgrade the firm’s debt, which could trigger covenants in its debt agreements to post even more collateral.

  “You scared the shit out of me last night,” Willumstad told Schreiber the following day, after spending the night contemplating the firm’s liquidity issues. The problem would soon be further compounded, Willumstad realized, with the firm scheduled to report a $5.3 billion loss in its second quarter.

  On this muggy July day, Willumstad was on his way to see Geithner, whom he had only met for the first time a month earlier, to sound him out about getting some help if the markets turned against him. The Federal Reserve Bank of New York did not regulate AIG, or any insurance company for that matter, but Willumstad figured that between AIG’s securities-lending business and its financial products unit, Geithner might take an interest in his problems. Even more he hoped that Geithner appreciated how closely AIG was interconnected with the rest of Wall Street, having written insurance policies worth hundreds of billions of dollars that the brokerage firms relied on as a hedge against other trades. Like it or not, their health depended on AIG’s health.

  “No reason to panic, no reason to believe anything bad is going to happen,” Willumstad said after Geithner had greeted him with his usual firm, athletic handshake and invited him back into his office. “But we’ve got this securities lending program….”

  He explained that AIG lent out high-grade securities like treasuries in exchange for cash. Normally it would have been a safe business, but because the company had invested that cash in subprime mortgages that had lost enormous value, no one could peg their exact price, which made them nearly impossible to sell. If AIG’s counterparties—the firms on the other side of the trade—should all demand their cash back at the same time, Willumstad said, he could run into a serious problem.

  “You’ve made the Fed window available to the broker-dealers,” he continued. “What’s the likelihood, if AIG had a crisis, that we could come to the Fed for liquidity? We’ve got billions, hundreds of billions of dollars of securities, marketable collateral.”

  “Well, we’ve never done that before,” Geithner replied briskly, meaning that the Federal Reserve had never made a loan available to an insurance company, and he seemed none too swayed by Willumstad’s argument.

  “I can appreciate that,” Willumstad replied. “You never did it for brokers before either, but obviously there’s some room here.” After Bear Stearns
’s near-death experience, the Fed had decided to open the discount window to brokerage firms like Goldman Sachs, Morgan Stanley, Merrill Lynch, and Lehman.

  “Yes,” Geithner acknowledged, but said that it would require the approval of the entire Fed board and, he added pointedly, “I would only recommend it if I thought I was making a good credit decision.”

  He then delivered to Willumstad the same warning that he had given to Fuld the month before when Fuld had sought bank holding company status for Lehman.

  “I think the problem is it’s going to exacerbate what you’re trying to avoid,” he said. “When it would get disclosed, that would cause concern among the counterparties. It would exacerbate anything we had.”

  Willumstad could see he wasn’t getting anywhere with his argument as Geithner rose to indicate that he had to get to his next meeting, saying only, “Keep me informed.”

  On July 29 Lehman’s Gulfstream circled over the airport in Anchorage, Alaska, preparing for its approach to land to refuel. Aboard was Dick Fuld, heading back from Hong Kong, where he and a small Lehman team had met with Min Euoo Sung of the Korea Development Bank.

  Fuld was in uncharacteristically good spirits that day, confident that he was finally getting closer to a deal. He had had a productive conversation with KDB, and both sides had agreed to continue talking. It would still be a “long putt,” he knew, but KDB had become his best hope. Min had indicated that he would be interested in buying a majority stake in Lehman. He knew Min was still anxious about Lehman’s real estate portfolio—the toxic assets weighing it—but Min also seemed to be upbeat about the prospect of making KDB a major player on the world stage. There hadn’t been much discussion about price at the meeting at the Grand Hyatt in downtown Hong Kong, but Fuld was confident that a deal might finally be at hand.