Too Big to Fail

by Andrew Ross Sorkin

  On the flight over, Flowers had studied Lehman’s second-quarter report from the day before and had focused on what he knew was going to be the big discussion point: the value of Lehman’s real estate assets. Could they possibly be worth $25 to $30 billion?

  Curl, Flowers, and Goldfield set up operations in a conference room that Sullivan & Cromwell provided, laid out with coffee and pastries.

  This was going to be a long day.

  With twenty-four hours to mull over Lehman’s SpinCo plan, Wall Street analysts turned against it—and the firm—en masse. They blasted out skeptical e-mails to clients on Thursday morning, adding to the weight that was already dragging down Lehman’s shares. The stock price had ended the previous day down 7 percent at $7.25; it was about to sink even lower.

  “Management did not successfully put to rest the issues that had been pressuring the stock,” William Tanona, an analyst at Goldman Sachs, declared in his e-mail.

  Michael Mayo, an analyst who had kept a buy rating on Lehman shares since April 2007, sent out an even bleaker prognosis, given his concerns about the possible fallout as credit-rating firms grew more bearish about Lehman: “The change in rating agency posture is an unexpected negative that may create a distressed sale situation.” In other words, a fire sale could be next. His buy rating was summarily removed.

  Guy Moszkowski of Merrill Lynch was also grim on the subject of Lehman’s sale prospects, writing that the firm could be forced to accept a “take-under”—Wall Street parlance for a takeover at a price below where a company’s shares are trading.

  Even analysts who believed that Lehman was basically sound were beginning to see that it had become a matter of perception trumping fundamentals: Lehman’s tumbling stock price inflamed the market’s fears, creating a self-fulfilling prophecy that was forcing Lehman to find a buyer, and fast.

  As Wall Street analysts seemed poised to write the epitaph for Dick Fuld’s firm, the only person to come to his public defense was John Mack, the man who Fuld had hoped would be his merger partner. Mack was quoted in the Times that morning as saying, “He is as feisty as ever, but there is no question this is wearing on him, as it would wear on anyone.”

  In private, however, Mack had just delivered shattering news in a phone call to Fuld: He didn’t believe there was a good reason for Morgan Stanley to move forward with the talks.

  However, there were still signs of life. Tim Geithner confirmed to Fuld that Barclays was indeed interested in bidding for the company, even though they had not contacted Fuld directly, and gave him Diamond’s phone number in London.

  “He knows you’ll be calling,” Geithner assured him.

  “I understand I’m supposed to call you,” Fuld said when he later reached Diamond.

  Diamond, however, was clearly flustered, as he thought he had been explicit with Geithner that he didn’t want to talk directly with Fuld about a deal. A deal would have to be brokered by the U.S. government.

  “I think we should talk,” Fuld said, trying to engage with him.

  “I don’t see an opportunity for us here,” Diamond answered.

  Fuld couldn’t understand what was going on. He had been told by Geithner to make this contact, and now Diamond was telling him that he wasn’t interested?

  Unwilling to force the issue, he ended the conversation and called back Geithner.

  “I just got off the phone with Bob Diamond,” he told Geithner heatedly. “He says he’s not interested. I thought you said he wanted to talk to us?”

  “Yes, he does,” Geithner insisted. “You should call him back.”

  Five minutes later, he tried Diamond again.

  “I just told you that we’re not interested,” Diamond repeated.

  Fuld, by now feeling as if he were part of some kind of charade, again phoned Geithner. “I don’t know what’s going on here. I’ve called him twice, and both times he says he doesn’t want to talk to me. You tell me he’s interested. He says he’s not.”

  Geithner promised he’d reach out to Diamond and urged Fuld to try him one last time.

  On his final attempt, Diamond was suddenly willing to talk.

  “We’re going to be flying over tonight,” Diamond said. “I’ll have a team ready to go by Friday morning.”

  With that sentence, it was official: Barclays and Bank of America were now in competition.

  What Fuld hadn’t been aware of was that for the entire morning, Diamond and his team had already been in contact with Geithner and Paulson and had come to an agreement that Barclays would examine Lehman’s books as soon as possible. Fuld’s role in any rescue effort was becoming a polite formality.

  Before he left for New York that night, Diamond had hoped to receive some assurances that his trip would be worthwhile. On his call with Paulson, Diamond had specifically asked if Barclays could be the exclusive bidder for Lehman. He had read the news about Bank of America’s interest, and he knew firsthand that it could be a formidable rival—and a potential spoiler.

  A year earlier, Bank of America had jumped into the takeover battle for the Dutch bank ABN AMRO, a duel that pitted Barclays against a group that included the Royal Bank of Scotland. By agreeing to buy Chicago’s LaSalle Bank from ABN for $21 billion, Bank of America had effectively snatched the crown jewel of the deal, which the RBS group was particularly coveting and whose absence from the portfolio made it more difficult to outbid Barclays. In the end, Barclays lost the bidding war for ABN, but Bank of America still got LaSalle. The failed deal was a blow for Diamond and his expansionist dreams, and he had always believed that Bank of America had hugely overpaid for the property.

  “If BofA is going to be there, don’t embarrass us,” Diamond told Paulson. “Don’t get us to do a deal and have BofA top us.”

  “You can’t have an exclusive,” Paulson responded. “But let me tell you, you’re in a strong position, and I’ll make sure you’re not embarrassed.”

  Before the call ended, Diamond wanted to make another thing clear: He was looking for a “Jamie Deal”—in other words, he might come looking for some form of government help.

  Paulson stated firmly that no assistance from the government would be forthcoming, but added, “We’ll figure out how to get you help.”

  As Tom Russo burst into Dick Fuld’s office, the glum look on his face got Fuld’s immediate attention, which was fairly remarkable, considering the general somberness on the thirty-first floor.

  “What?” Fuld barked.

  “I just got off the phone with Tom Baxter,” Russo said, referring to the general counsel of the Federal Reserve of New York. “He said that Geithner wants you to resign from the board of the NY Fed.” Russo paused to allow Fuld to take that news in before adding, “That given our position, it’s too complicated, too many conflicts.”

  Geithner’s request should not have come as a shock, for if there was even the possibility that the government was going to have to put up money as part of a deal to find Lehman a buyer, the last thing he would have wanted was to be seen as helping a member of his own board, an insider. The slightest appearance of favoritism could prove disastrous.

  Fuld, even so, took the message as a personal slight and stared morosely down at the table. For a moment it looked as if he might cry, but he steadied himself and whispered, “I can’t believe this.”

  Together Fuld and Russo dictated a resignation letter addressed to Stephen Friedman, chairman of the board of directors:

  Dear Steve,

  It is with deep regret that I hereby tender my resignation as a member of the Board of Directors of the Federal Reserve Bank of New York. In light of my current business situation at Lehman Brothers, I unfortunately do not have the time to devote to Board matters and, therefore, feel it is in the best interests of the Board that I resign, effective immediately. I have very much enjoyed my time on the Board and have enormous respect for both the Board and the institution. Thank you.

  Sincerely,

  With a restrained but heavy
sigh, Fuld added his signature, scribbling a huge “D” in place above “Dick.”

  At 70 Pine Street the pressure was building as Bob Willumstad paced his office ahead of a crucial meeting that morning with the credit-rating agency, which had been making menacing noises about downgrades. He had just gotten off the phone with Geithner to follow up on their meeting about turning AIG into a broker-dealer, and to apply a little additional pressure. “We’re a little busy right now with Lehman,” Geithner apologized. “But let’s talk again tomorrow morning.”

  It was only 10:30 a.m., but the marketplace was already sensing the nervousness that Willumstad had been trying his best to conceal all week. The cost to insure the debt of AIG had jumped by 15 percent to 612 basis points, the highest level in its history. That meant that it would cost investors $612,000 to insure $10 million of AIG’s debt every year for the next five years. With Lehman clearly desperate to raise money, investors were betting AIG was soon going to face the same struggle. It might also have to pay out astronomical amounts to investors who were loading up on insurance to protect themselves from a potential Lehman default.

  To make matters worse, Hank Greenberg, being deposed that day by the New York State attorney general about previous questionable accounting practices at AIG, badgered Willumstad at every chance. “What the hell are you people waiting for?” he demanded, wanting to know why efforts to shore up the company hadn’t been moving more quickly.

  Amid all the other pressures, Willumstad was still pressing to settle the long-running lawsuit that Greenberg had brought against the firm after he had been ousted. He had been counting on Greenberg’s helping the firm raise some capital by leveraging his relationships in Asia, where he had built AIG into a powerhouse that dominated the tricky and semitransparent Japanese and Chinese markets. He told Greenberg he’d have his lawyer, Jamie Gamble, at Simpson Thacher, set up a meeting with Greenberg’s lawyer, David Boies, to try to come up with a settlement Greenberg could live with.

  Perhaps the most pressing problem weighing on Willumstad was the result of a conversation he had had with Jamie Dimon earlier in the week. “We seem to be not getting enough done,” Willumstad had told him, urging him to help raise capital or lend the firm the money himself.

  “Well, you know, you got a bigger problem than we had anticipated,” Dimon replied. “Our models show you’re running out of money next week.”

  It was then that Willumstad accepted the fact that JP Morgan might well not be willing to provide any further funds. AIG’s treasurer, Robert Gender, had already warned him that that might be the case, but Willumstad hadn’t fully believed him. “JP Morgan’s always tough,” he reminded Gender. “Citi will do anything you ask them to do; they just say yes.” But the prudent Gender only acidly replied, “Quite frankly, we can use some of the discipline that JP Morgan is pushing on us.”

  Dimon had been encouraging Willumstad to just come up with a plan, even if it wasn’t perfect. “It doesn’t have to be in place,” Dimon told him. “You just have to tell the markets what you’re going do and then go and do it. If you need to raise capital, tell them you need to raise capital.”

  A lot of good that did Lehman yesterday, Willumstad thought.

  Finally, the time came for the dreaded meeting with Moody’s. Steve Black from JP Morgan had come downtown to lend some credibility to the affair and to help answer questions about AIG’s plans to raise capital. It was one thing for Willumstad to state that he had every intention of raising capital and quite another entirely to have the president of JP Morgan affirm that he intended to support the company in that effort. The stakes were high: If the agency cut AIG’s credit rating by even one notch, it could trigger a collateral call of $10.5 billion. If Standard & Poor’s followed suit, which was likely—“the blind leading the blind,” Willumstad said of them—the figure would rise to $13.3 billion. Should that happen, and AIG be unable to come up with the extra capital, it would be a virtual death sentence.

  No more than fifteen minutes into the meeting, the Moody’s analyst made it clear that the agency would downgrade AIG by at least one notch and possibly two. By Willumstad’s calculations, if they did so on Monday, the company would have at least three days before it would have to post the collateral. That meant he had until Wednesday, or at the latest, Thursday, to come up with an astronomical amount of money.

  JP Morgan’s Black feared they had even less time; by his count, Tuesday morning would be their deadline. After the meeting, he pulled Willumstad aside and warned him, “You guys are going to get downgraded so you better start figuring out now what to do.”

  Willumstad nodded. “We need to prepare for that. I totally agree with that.”

  Black left the building even more down on the company than when he had arrived. Nobody, he thought, was moving nearly as fast as he needed to.

  In the General Motors Building, which occupies an entire block on Fifth Avenue and Fifty-ninth Street, Harvey Miller, the legendary bankruptcy lawyer at Weil, Gotshal & Manges, got up from his desk and began pacing. As he made a circuit of his office, he gazed at the miniature Texaco trucks and Eastern Airlines jets that dotted his bookshelves, mementoes of two of his most famous cases.

  At seventy-five, Miller was considered the dean of bankruptcy law, and he billed clients nearly $1,000 an hour for his services. Besides Texaco and Eastern, he had been involved in the bankruptcies of Sunbeam, Drexel Burnham Lambert, and Enron, and was also among the lawyers who represented the city of New York during its financial crisis in the 1970s.

  Always reassuringly calm, he was also known for his deftly tailored suits, his love of opera, and his ability to speak in long, eloquent paragraphs. He had grown up in the Gravesend neighborhood of Brooklyn, the son of a wood-flooring salesman, and was the first in his family to receive an education beyond high school, attending Brooklyn College. After a stint in the army, he went to Columbia Law.

  At that time, bankruptcy was one of the few areas of corporate finance that smaller, predominantly Jewish law firms dominated in the still-WASP-infected industry. In 1963 Miller joined the small bankruptcy shop Seligson & Morris; six years later, Ira Millstein, the governance guru, recruited Miller to start a bankruptcy and restructuring practice at Weil Gotshal.

  Earlier that afternoon, the firm’s chairman, Stephen J. Dannhauser, had phoned him and posed a startling question: Would the firm be available to do some preliminary work on Lehman—just in case? Miller said he understood; he had been reading the financial press. Lehman was a very important client—the firm’s biggest, in fact, and the source of more than $40 million in fees annually. He knew the company very well.

  Dannhauser had received a call from Steven Berkenfeld, a Lehman managing director, who told him they should get their ducks in order if things didn’t go well in the next seventy-two hours. Before Berkenfeld ended the call, he insisted that Dannhauser keep their conversation confidential—Berkenfeld hadn’t even told Fuld that he was contacting Weil Gotshal.

  As a bankruptcy lawyer, Miller was well accustomed to engaging in these delicate pas de deux with clients. “Bankruptcy,” he once said, “is like dancing with an eight-hundred-pound gorilla. You dance as long as the gorilla wants to dance.”

  Just a few hours later, however, Miller received another call from the embattled bank.

  “I’m Tom Russo, the chief legal officer of Lehman Brothers,” the voice on the other end of the line bellowed. “Are you working on Lehman?”

  Miller, who did not know Russo, was taken aback. “Well, yes, as it happens.”

  Russo had no interest in discussing any details but wanted to deliver a message: “You know you can’t talk about this to anybody. It’s a very tense situation. We can’t have any rumors coming out.”

  Miller was about to assure him that he appreciated the urgency of the matter when Russo asked anxiously, “How many people do you have working on it?”

  “Ah, maybe four,” Miller told him. “It’s ah, preliminary at this point.”<
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  “Yes, preliminary,” Russo insisted. “Don’t add any more people. We’ve got to keep it contained.”

  Russo ended the call, leaving a baffled Miller to wonder precisely what was going on.

  With his team over at Sullivan & Cromwell working with Bank of America, Dick Fuld decided to call Ken Lewis in Charlotte. After all, if they were going to do a deal, he figured that they should start talking CEO to CEO.

  When Fuld reached Lewis. he launched into a heartfelt soliloquy about working together and how excited he was about the merger, marrying Lehman Brothers’ top-flight investment banking franchise with Bank of America’s massive commercial bank. The resources of the combined entity, he suggested, could match those of JP Morgan and Citigroup, finally making Bank of America a true financial supermarket.

  Lewis listened patiently, not exactly certain how to respond. In his mind he wasn’t negotiating with Fuld; he was negotiating with the government. Whatever Fuld had to say was, frankly, irrelevant.

  Before ending the call, Fuld, feeling confident, said: “You and I both know we’re doing this deal. Glad we’re partners.”

  BlackRock was in the middle of a two-day board meeting at its headquarters on Fiftieth Street, just off Madison Avenue, when the markets closed for the day. As a part owner of BlackRock, Merrill has two seats on Black-Rock’s board, and John Thain and Greg Fleming, who were attending that day, quickly consulted their BlackBerrys to check the closing prices. Merrill’s shares had fallen 16.6 percent to $19.43, the most of any investment bank that day besides Lehman, whose shares had tumbled 42 percent, to $4.22. If Lehman was in this much trouble, the general thinking seemed to be going, Merrill could well be next.

  During a break in the meeting, Fleming stepped outside to make a phone call. He had been thinking all day about the conversation he had had with Herlihy about the possibility of a deal with Bank of America. He had yet to approach Thain about it, waiting for just the right opportunity to present itself.