Too Big to Fail

by Andrew Ross Sorkin

  He had, however, spoken privately with John Finnegan, a Merrill board member with whom he was close. Finnegan, who like Fleming tended to be nervous by nature, had worried that Thain would have little interest in selling the firm; he had, after all, only been named CEO ten months earlier.

  The person Fleming needed to contact now was Rodgin Cohen, also a close friend and, he knew, Lehman’s lawyer. Fleming was eager to get a reading on how the talks with Bank of America were going and how desperate the situation had become for Lehman—and, consequently, for Merrill.

  When Cohen, who had been in a conference room with the Lehman team meeting with Bank of America, stepped out to take the call, Fleming greeted him casually, as if this were merely a social communication. After the obligatory pleasantries, he off handedly remarked on Merrill’s stock price decline, and then told Cohen, “We’re thinking about our options. I don’t know how much runway we have.”

  But Cohen was quickly onto Fleming; he knew Merrill was in no position to buy Lehman. And, being a student of the M&A business, he knew Fleming probably wanted to do a deal with Bank of America, thwarting Lehman’s own efforts.

  “There’s not much I can say,” Cohen told him.

  Abandoning any attempt to conceal his motives, Fleming confided in Cohen, “We’ve got to do a deal. The numbers are looking too risky. If Lehman goes, we’ll be next.”

  Cohen didn’t know how to respond, other than to excuse himself as quickly as possible. For now, at least, he would keep the conversation confidential.

  When Steve Black got back to his office at JP Morgan from AIG, he described the meeting to Dimon as “a fucking nightmare.” He asked Tim Main to call Brian Schreiber to get an update on AIG’s latest forecast, and to see if Schreiber had signed the engagement letter—essentially a specification of JP Morgan’s terms for trying to put AIG back together again.

  Main told Black that the document had not yet been signed but that he would call that afternoon to check on its status. “Can we schedule my weekly beating at two p.m.?” he asked, only half-joking. His relationship with the AIG folks remained as frosty as ever.

  When Main finally got through to Schreiber, he asked without any preamble, “So, where are you on the engagement letter?”

  Schreiber had always believed that the terms of the engagement letter were excessive. Not only was JP Morgan asking for a $10 million fee, but the bank was also demanding that it be guaranteed work on any big AIG assignment over the next two years.

  “Where are you on the repo commitment?” Schreiber retorted indignantly.

  Main, who was already angry about rumors he’d heard that Schreiber had also been talking to Blackstone and Deutsche Bank, finally lost his temper. “Are you fucking kidding? You think we’re going to lend you money?” he barked. But he was just getting warmed up. “You’re running a shitty process. Your company is fucked! You’re working with other bankers that you’re not telling us about. You’re carving it all up.”

  “Don’t scream at me,” Schreiber replied coldly. “I’m not going to take this from you. I’ve got to talk to Bob.”

  Five minutes later Schreiber was angrily recounting the conversation to Willumstad, who in turn called Black to demand an explanation for Main’s behavior.

  Instead of offering an apology, though, Black exploded at him as well. “There’s no sense of urgency down there; you guys don’t have anything close to the information that you need to be trying to make decisions,” Black said. “Every time we ask for something, you drag your feet. We sent an engagement letter three weeks ago, and Brian is still dickin’ around with signing it.

  “We’ll do whatever you want us to do,” Black finally said wearily. “But if this is the way it’s going to go, then you might as well…we should probably resign. You should get somebody else. This has gotten to a poisonous point, and the people that work for you don’t get the position that you guys are in.”

  “If you were that upset about it, why didn’t you just call me?” Willumstad asked.

  When the call came in from Ken Lewis late Thursday afternoon, Paulson knew what he was about to hear.

  “We’ve looked at it and we can’t do it—we can’t do it without government assistance,” Lewis said levelly. “We just can’t do it because we can’t get there.” Like many of Lehman’s critics at the time, including the anxious shareholders who were flooding the market with sell orders, Lewis said that the valuations that Lehman had placed on its assets were far too high. Buying them could expose Bank of America to huge risks.

  Given that Bob Diamond of Barclays had already come to him, hat in hand, looking for a government assist in a Lehman deal, Paulson had fully expected Lewis would do the same.

  But Paulson still wasn’t prepared to resort to drawing on federal money—at least not yet. It was politically unpalatable, especially with the Fannie and Freddie bailouts still making headlines. And if this was going to become a negotiation, Paulson didn’t want to show all his cards so early on.

  He knew, however, that he needed to keep Bank of America in the hunt, so he offered, “Okay, if you need help on assets, you tell us what you need help on, and we will come up with a way to get there.”

  Lewis, nonplussed, replied, “I thought you said there would be no public money.”

  “I will work on this,” Paulson promised. “We will get the private sector to get involved.”

  Private-sector involvement was a concept that Paulson and Geithner had been discussing all day—the assembly of a consortium of banks to help subsidize a sale of Lehman, if Bank of America or Barclays refused to do the deal on its own. But neither Paulson nor Geithner had completely fleshed out the idea yet, and even in the best of times, herding bankers was a feat far from easy.

  Lewis paused, not at all pleased with what Paulson seemed to be suggesting. He didn’t want to get involved in a quasi-public-private rescue; he wanted a “Jamie Deal.” And he knew full well that his rivals were unlikely to want to foot the bill so he could buy Lehman for a song.

  Lewis nonetheless agreed that he would keep examining Lehman with an eye toward making a bid. With so much at stake, he assumed he would ultimately get some sort of assistance—whatever form it might take.

  On Thursday afternoon, David Boies, Hank Greenberg’s lawyer, arrived at the offices of Simpson Thacher to meet with AIG’s lawyers: Dick Beattie, the chairman of the firm; and Jamie Gamble. Only a small circle knew about the meeting or what it was intended to accomplish. After four years of public battles, AIG was about to reach a settlement with Greenberg, one that would bring him back into the company fold. Willumstad had instructed Beattie and Gamble to get in a room with Boies and hammer out a deal once and for all.

  Given the tumult in the market, Willumstad was eager to announce that Greenberg was returning to AIG as its chairman emeritus. The news would certainly come as a shock, but Willumstad was hoping the settlement might buy them some time and good will from investors, many of whom were still Greenberg loyalists.

  Willumstad also knew that Greenberg was fervent about helping AIG raise capital, and given Greenberg’s deep relationships with wealthy investors in Asia and the Middle East, he could prove to be an asset.

  They still had to work out the details, but they had come to an agreement in principle that would resolve the dispute. AIG would turn over $15 million worth of artwork, papers, and property that Greenberg believed was his and AIG would pay for Greenberg to defend himself in the dozens of shareholder lawsuits that had been brought against him. In return, Greenberg would turn over somewhere between 25 to 50 million AIG shares that had been held by Starr International in a trust, and had been at the center of the dispute. In total, the settlement would cost Greenberg as much as $860 million based on AIG’s share price that day, but it would end AIG’s $4.3 billion lawsuit against him, and would reinstall him within the company that he loved so dearly.

  With the basics of the settlement agreed, Boies, wearing a blue blazer and casual black Merri
ll shoes, thanked the other men and suggested that they try to memorialize the arrangement by getting Willumstad and Greenberg in the same room to wrap it up the following week.

  “Call me this weekend,” Boies said to them as he turned to leave.

  Paolo Tonucci, Lehman’s global treasurer, looked horror-stricken as he set down his cell phone. “I’ve got to talk to you right now!” he said quietly to Bart McDade and Rodgin Cohen. “We’ve got a real problem.”

  Everything had been going smoothly at Sullivan & Cromwell’s Midtown offices, where they had been helping Bank of America with its due diligence, but now, as Tonucci revealed, “JP Morgan is pulling another $5 billion in collateral from us! I just got off the phone with Jane Byers Russo [head of JP Morgan’s broker-dealer unit]. She says that we need to wire it by tomorrow. And she might pull another $10 billion by the weekend.”

  “What?” Cohen asked, clearly dismayed by the demands. “This sounds unbelievable. I don’t understand this. I know everyone’s in panic mode, but this is too much.”

  Tonucci shared the news with his boss, Ian Lowitt, Lehman’s CFO, and the rest of the room.

  “This is bullshit,” McGee yelled out, breaking an awkward silence.

  Tonucci and Lowitt called Fuld to tell him the news and to set up a conference call with Jamie Dimon. “Listen, we need you to send us the collateral,” Dimon told the group when he finally clicked into the call, saying it was a fair request to make given Lehman’s deterioriating position. Fuld calmly told Dimon he’d have his team work on it. Tonucci, however, whispered to the Lehman team, “Does Dick not understand? It’s almost operationally impossible for us to do that.” Dimon, too, worried that Fuld might be treating the matter far too casually. “Are you taking notes?” Dimon snapped. When the call ended, McDade was apoplectic. “We have to call the Fed,” he said. “Jamie can’t just do this.”

  Cohen, who had had the most experience of any of them with Fed matters, wasn’t so sure. “I’m quite sure Jamie has been there before us,” he told them. “Jamie’s tough. He wouldn’t have done this without the tacit approval of the Fed.”

  For the next ten minutes the room was a cacophony of different conversations taking place simultaneously, all on the common theme of, They’re trying to put us out of business! Finally they decided that the best step to take was to call Tim Geithner.

  When Cohen reached Geithner and put him on speakerphone, he quickly explained the situation to him, Geithner appeared unconcerned, as if he had been expecting their call. McGee shot a nervous glance at McDade, as if to say, We’re fucked. “I cannot advise a bank not to protect itself,” Geithner said unperturbedly.

  Cohen, politely hoping to get Geithner to realize that he believed JP Morgan was doing this to undermine its rival, asked, “Do they need that protection?”

  “I’m not in a position to judge that,” Geithner answered.

  At 6:00 p.m. Paulson joined a strategy call with Geithner, Bernanke, and Cox. He felt they were about to go into crisis mode and feared another Bear Stearns–like weekend. This time, however, he was determined that it end differently. He believed they needed to prepare what he called a “LTCM-like solution”—in other words, he was committed to the idea of encouraging firms in the private sector to band together and put their own money up to somehow save Lehman Brothers. Geithner was supporting the concept, and apparently some Wall Street chiefs were as well. Geithner had received calls from both John Thain of Merrill Lynch and Vikram Pandit of Citigroup earlier in the day suggesting just such a solution.

  Paulson was also deeply concerned about the apparent lack of resolve of both Bank of America and Barclays to “cross the finish line.” He had come to feel that Bank of America was merely going through the motions and was anxious that Barclays wasn’t especially serious about coming to an agreement either. “Listen, the thing about these Brits is that they always talk and they never close,” he told them. He also had a particular instinct about Barclays’ chairman, John Varley, whom he remembered from his Goldman days as a waffler. “Let me tell you,” Paulson said, “Varley is a weak man.”

  Perhaps most important, Paulson stressed, was that they couldn’t afford the political liability of putting up government money for Lehman as they had for Bear Stearns. “I can’t be Mr. Bailout,” he insisted, and given that everyone on the conference call had already lived through the backlash of that experience, they hardly needed convincing about not wanting to repeat it.

  Still, Geithner was a bit hesitant about taking such a severe stance in public, but only because, as he explained, “we don’t want to scare people away. We need as many bidders in this as possible.”

  Nonetheless, he quickly fell in line, and the four men made a pact: Unless something miraculous happened, they would plan to place calls to the CEOs of the major Wall Street houses late on Friday and have them all come down to the NY Fed, where they’d press them to come up with a private solution.

  In the meantime, Paulson instructed them, the message should be clear: No bailouts.

  Brian Schreiber, removing his thick-framed glassed to rub his eyes, could see from his examination of AIG’s daily cash tally that the firm could soon be out of money if it didn’t start selling assets quickly. He nervously began working through the list of people whom he could call whose companies would be capable of providing assistance almost immediately.

  The first name that occurred to him was Chris Flowers. His fund had several billion dollars available to buy financial-services assets, and as a former financial-services banker he understood the insurance business well enough that he could move instantly if he was interested. They had also worked together before; Flowers had sought to partner with the firm to buy some smaller insurance companies in the past.

  Schreiber tracked down Flowers over at Sullivan & Cromwell, still doing diligence on Lehman’s books.

  “We have a huge problem,” Schreiber told him. “We’re going to run out of cash shortly, um, and, you know, we only have, you know, one or two shots to get this right.”

  “Well, I’m in the middle of Lehman here,” Flowers replied. “I’m working with BofA.”

  “Is there any way you could come down here tomorrow?” Schreiber persisted.

  “We’ll come take a look,” he said somewhat noncommittally, uncertain whether he’d be finished with Lehman by then, and then added, “I see this is really important,.”

  After ending his conference call with Geithner and Bernanke, Paulson summoned Michele Davis, his head of communications, to his office.

  “So, I talked to Lewis and Diamond. They’re, of course, all saying that they want government money,” he told her. “And we’ve got Pelosi and everybody else all over us,” he added, referring to rumblings that the Speaker of the House had made expressing her disapproval of any more bailouts.

  Davis had brought with her a handful of articles that had already been published by the major papers on the Internet, and it was clear that a possible bailout would be the primary focus of the following day’s news cycle.

  A Dow Jones article published at 7:03 p.m., just minutes earlier, opened: “With a beleaguered Lehman Brothers Holdings Inc. likely to be sold, one key issue is what a backstop from the Federal Reserve, if it materialized, would look like.”

  “You cannot have this in tomorrow’s headlines, tomorrow’s newspapers saying this,” Davis said, shaking her head. “Everyone is going to think, Oh, Hank is coming with his checkbook. That is not the way you want to start this negotiation.” As a former staffer herself, she was also aware of the Bush administration’s stand on the matter, and knew how politically problematic it would be if the possibility of a bailout of a major Wall Street firm were even being entertained.

  Although the subject was left unspoken, both she and Paulson knew another reason a Lehman bailout could quickly become a public relations nightmare: Bush’s brother, Jeb, the former of governor of Florida, worked as an adviser to Lehman’s private-equity business. Bush’s cousin, Georg
e H. Walker IV, was on the firm’s executive committee. And then there was Paulson’s brother, Richard. The press, needless to say, would have a field day.

  “We should make some calls,” she urged him, subtly suggesting they begin leaking to the press word that the government wouldn’t be pursuing any bailout of Lehman.

  Paulson mulled over his dilemma. He had always opted to be cautious with the press and hated the very idea of leaking as a tactic. But he trusted Davis’s instincts, and in any case, he preferred not to get his own hands dirty in the matter.

  “Do what we need to do,” he told her. “Just, you know, don’t have it be me on the record.”

  As soon as Paulson awoke on Friday, he began poring through the morning papers, looking for evidence of Davis’s handiwork. The message was supposed to have been made clear: Read Our Lips: No More Bailouts.

  The mood in Washington was not hard to discern: There was no desire whatsoever for any further Wall Street rescues. All punditry could talk about was moral hazard, as if it were some sort of emerging disease that had just reached pandemic proportions. Bail out Lehman, the thinking went, and you will make bailouts the default solution at a time when no firm seems safe.

  And what could be more satisfying than having your decision—the buck stopped there, thank you very much—manifested on the front pages of the country’s leading publications? Paulson first turned expectantly to the newspaper of financial record, the Wall Street Journal, and was sorely disappointed. The A1 article about the financial crisis merely tiptoed around the issue without ever being forceful enough about it, he thought as he read the piece. As close as the reporter got to explaining his position was this sentence: “Federal officials currently aren’t expected to structure a bailout along the lines of the Bear transaction or this past weekend’s rescue of mortgage giants Fannie Mae and Freddie Mac.”