Too Big to Fail

by Andrew Ross Sorkin

  The New York Times was even worse: “But while the Treasury Department and Fed were working to broker an orderly sale of Lehman, it was unclear whether the Fed would stand behind any deal, particularly after the Bush administration took control of the nation’s two largest mortgage finance companies only days ago.”

  No, that didn’t quite capture what they had been trying to convey, Paulson thought.

  He turned to the Journal’s editorial page, where the air was typically more rarified, and was able to take solace, as conservatives so often had, in its hyperintellectual and at times harsh right-wing opinions. The typically unsigned editorial was called “Lehman’s Fate,” and its position was right out of Paulson’s playbook

  “At least in the Bear case,” the Journal editorial read, “there was some legitimate fear of systemic risk. The Federal Reserve’s discount window hadn’t yet been opened to investment banks, and so there was some chance of a larger liquidity panic.

  “That’s far less likely with Lehman. The discount window is now wide open to Merrill Lynch and Morgan Stanley, among others, and federal regulators have had months to inspect the value of Lehman’s assets and its various counterparties. If the feds step in to save Lehman after Bear and Fannie Mae, we will no longer have exceptions forged in a crisis. We will have a new de facto federal policy of underwriting Wall Street that will encourage even more reckless risk taking.”

  Yes, yes, all true, Paulson thought as he finished the editorial. Still, it didn’t go far enough. He needed somehow to make it clear to all the banks that there would be no handouts, no more “Jamie Deals.” And he needed to do so in a way that would leave no room for misunderstanding.

  When he arrived at the office Paulson walked down the hall into Michele Davis’s office and asked sullenly, “What do we do?”

  “I’d rather say today that we don’t want to use our money and on Sunday night have to explain why we were backed into a corner,” Davis told him. “You want me to call Liesman?” she asked.

  Liesman was Steve Liesman, CNBC’s economics reporter, known popularly as “The Professor.” Davis had a good relationship with him and had successfully leaked other information to him; Paulson considered him both intelligent and sympathetic to their cause. He could get the word out quickly and accurately.

  Yes, the Professor, Paulson smiled. He’ll know what to do with this.

  As Ed Herlihy sat in his office working on Bank of America’s bid, he kept his TV on mute, until at around 9:15 a.m. he saw the headline crawl across the bottom of CNBC’s screen—“Breaking News: Source: There will be no government money in the resolution of LEH situation”—and quickly turned up the volume to hear what Steve Liesman was telling David Faber, the network’s mergers reporter.

  “Let me start here with a comment that I just got from a person familiar with Paulson, State Secretary Treasurer [sic], Hank Paulson,” Liesman explained. “He’s saying there will be no government money in the resolution of this situation.”

  Herlihy turned the volume even higher.

  “They’re saying there are two things that make the Lehman deal different,” Liesman continued. “The market’s been aware and had time to prepare for over six months, and the second is the PDCF, that is, the access of the investment banks to the Fed’s emergency window that exists now, to allow for an orderly process.”

  It was a lot to take in, and the Professor turned the floor over to his colleague. “David, what do you think of that?”

  “An interesting gamble,” Faber replied. “Would the government be willing to say, ‘Hey, you’re on your own?’ There’s divided opinion in terms of what the ultimate risk will be to the creditors, to everybody involved in the credit default swap market where Lehman certainly is a counterparty on many trades.”

  Liesman added: “I’m sure the Federal Reserve is looking for a situation where it can say, ‘There is moral hazard out there. You will take a hit if you did not pay attention for the last six months.’”

  Herlihy couldn’t believe what he was hearing and ran into the conference room across the way where an army of bankers and Bank of America executives was mulling over documents.

  “Did you just see what they just said on CNBC?” Herlihy asked Curl, almost out of breath. Curl not only hadn’t, but seemed slightly annoyed that he’d even been asked the question.

  “Look, guys, we got a real problem here,” Herlihy insisted, after noticing he wasn’t getting much of a reaction from anyone in the room.

  After Herlihy recounted the details of the Liesman interview, Curl only rolled his eyes. Why was Herlihy taking the CNBC report so seriously? To him, the channel was a professional rumor mill.

  “It’s coming from Treasury,” Herlihy stressed again. “That’s Paulson. They’re trying to send us a message!”

  Herlihy was media-savvy enough to know how the game worked: When he had been at Treasury just a week earlier during the takeover of Fannie-Freddie, he had watched the department deftly leak news out to the public through its favorite reporter, Liesman.

  The room turned sour, as even Curl acknowledged that Herlihy had a point.

  “How serious do you think they are?” Curl asked.

  Before heading back uptown for the second day of the BlackRock board meeting, John Thain decided to hold a conference call with his own board. With the markets gyrating and rumors flying, he wanted to make it clear publicly that Merrill was solid. Already there was a news report that morning quoting Malcolm Polley, chief investment officer at Stewart Capital Advisors, saying, “I think the market’s telling you that if Lehman is going to go away, Merrill is probably the next victim.”

  Thain first briefed the board on recent market swings, which showed no sign of stopping. One look at the futures made it clear that stocks were likely to sink at the opening bell. With Merrill down 16 percent the previous day, things were only going to get worse.

  The discussion quickly turned to Lehman. Thain told the board what he knew, which wasn’t too different from what had been reported in the papers, except that Thain was getting his information directly from Geithner: Bank of America and Barclays were both vying to buy Lehman.

  John Finnegan, a chief executive of the insurer Chubb, sounded worried. “Lehman is going down, and the shorts are coming after us next,” he told Thain. “Tell me how this story is going to end differently.”

  Thain, frustrated by the remark, had never liked being challenged. “We are not Lehman,” he said, his eyes flashing behind his glasses, and then repeated for emphasis, “We’re not Lehman.”

  Regaining his usual composure, Thain calmly rehearsed the virtues of Merrill. “We have a wealth-management business that’s going to have value no matter what,” he told the board. “And we own half of BlackRock, which would also have value no matter what—so our stock’s not going to zero.”

  Fuld was growing restless. It was 9:30 a.m., Lehman’s stock opened down 9 percent to $3.84, and he hadn’t heard from Diamond in over twelve hours.

  “So where are we?” Fuld asked Diamond when he finally reached him.

  “I’ve literally just gotten the okay from my board that we can pursue this,” said Diamond, who had arrived in New York from London after midnight the night before. “We’ve just begun doing diligence with your public filings.”

  Before he continued, however, Diamond decided that he needed to be blunt with Fuld. “To be honest,” he said stiffly, “this is a horrible situation for you, because we’re only going to be interested if the price is quite distressed.”

  Fuld, leaning back in his desk chair, looked at Russo, who had taken a seat across the desk for the call. He understood.

  “You and I should talk, because you should know exactly what my ideas are, what my plans are,” Diamond said. He suggested meeting at noon at the Racquet and Tennis Club, a members-only establishment on Park Avenue and Fifty-second Street, where they would be able to get a private meeting room.

  “No, no, no. You don’t understand. I
can’t walk out of here,” Fuld insisted. “There’s photographers all over the place. Why don’t you come over here? We can sneak you in the back. I’ll send my car for you.”

  “AIG Shares Fall 20 Percent on Mortgage Woes” proclaimed the Reuters headline at 10:14 a.m.

  Catherine Seifert, a Standard & Poor’s analyst, had just released a research note saying that the stock was falling on “concerns about AIG’s ability to shed its troubled mortgage-related assets, and we expect the shares to remain volatile as investors await news from the company.”

  As he followed these stories with increasing alarm, Bob Willumstad decided to call Jamie Dimon. He was increasingly frusterated with the JP Morgan team and needed assurances.

  “Jamie, we’re going to get downgraded,” he told him. “You need to help me figure out how to get $18 billion. There’s no plan for the end of September anymore,” he added, reffering to his plan to announce the results of his firmwide review and a new strategy at the end of the month. He stopped to let that sink in and then continued, “You know, if you guys can’t help us, tell me now, but we’ve got to do something this weekend. We hired you guys to do this,” he said, his voice rising ever so slightly. “Listen, just tell me if you can’t, just tell me now.”

  “Look, we want to make this work,” Dimon said, sounding a contrite note. “Give me five minutes and I’ll call you back.”

  When he phoned back he apologized on behalf of the firm and said that he would take Black off the case; his other lieutenant, Doug Braunstein, who ran the firm’s investment banking practice, would now be in charge. Braunstein, a no-nonsense deal maker, had been entrusted with some of the firm’s biggest transactions after working his way up the ranks, initially at First Boston in the 1980s, and then at Chase. He helped negotiate the firm’s acquisition of JP Morgan, its purchase of Bank One (bringing Dimon with it), and then the Bear Stearns deal. “We’re going to send Braunstein down with the team, and we’re going to see what we can do about raising capital for you over the weekend.” Dimon promised him that he’d keep “the trains on the tracks.”

  As he ended the conversation with Dimon, another call came in—Tim Geithner, who was finally getting back to Willumstad.

  “So, where are we?” Geithner asked.

  “We’re working on a capital raise,” Willumstad explained. “And we’re talking to some bidders for assets that may come in this weekend. We expect to have some more information later in the day.”

  “We’re going to send over some of our market guys this morning to help,” Geithner told him in a tone that made it clear that this was not an offer but an order. “Keep me posted,” Geithner said before hanging up.

  The conversation had lasted no more than thirty seconds.

  By now Hank Paulson had become so agitated by the problems at Lehman that he scarcely noticed his assistant, Christal West, trying to get his attention. Alistair Darling, the chancellor of the Exchequer of Britain, was on the line.

  Paulson had gotten to know Darling over the past two years, and though they had visited each other on both sides of the Atlantic, they had not grown close. Paulson considered Darling more a politician than a businessman, and he had nothing like the experience that Paulson himself had had in financial markets. But he respected Darling’s judgment and admired the quick and decisive action he had taken a year earlier when Northern Rock, one of Britain’s biggest mortgage lenders, was on the brink of failing. Darling has prevented a run on the bank by authorizing the Bank of England to lend Northern Rock billions of dollars to guarantee its deposits. That incident had been an early wake-up call for Paulson.

  Darling, who had just ended a daylong meeting in Nice with other European finance ministers, made a bit of chitchat and, after an awkward pause, said that he was calling about Barclays. “You should know that we have serious concerns about this deal,” he told Paulson sternly.

  Paulson tried to assuage him, explaining that there was another bidder, Bank of America, involved in the matter as well. He also spoke about the systemic importance of Lehman Brothers to the global economy and stressed how a deal between Barclays and Lehman would turn Barclays into an international giant with the might of Wall Street behind it. Paulson explained that he was trying to put together an industry consortium to aid a bid by either Barclays or Bank of America.

  Nonetheless, with characteristic British understatement, Darling continued to express apprehension about any potential purchase, and said adamantly, “Barclays shouldn’t take on any more risk than they could possibly manage.”

  Paulson, confidently dismissing his concerns, promised him he’d keep him updated throughout the weekend.

  Bob Diamond arrived at Lehman’s headquarters in Fuld’s Mercedes and was taken through the back entrance, avoiding the battalion of cameras stationed out front. Hoping to keep any of Lehman’s staff from seeing the visitor, the firm’s security team shuttled him up in the building’s freight elevator and hurriedly led him to Fuld’s office.

  Fuld offered him a cup of coffee, and between Fuld’s anxiety and Diamond’s not having slept, they both looked like hell.

  Diamond was clearly in a rush to get to Simpson Thacher, where his team of bankers had just begun diligence, and he wanted to dig into the numbers himself. He walked Fuld through the day’s plan and then discussed the various synergies and overlaps between the two firms.

  In the middle of Diamond’s presentation, Fuld interrupted him and told him there was something he wanted to get off his chest. An almost frightening intensity came over him as he began to speak.

  “Look into the whites of my eyes,” he said. “There isn’t enough room for both of us at the top here. We both know that.” He paused and stared at Diamond intently. “I’m willing to step aside to make this work for the firm”.

  For Fuld, it was the biggest concession he could offer: to give up the firm he loved.

  For Diamond, the moment was somewhat baffling. He had never imagined Fuld would stay; he didn’t want him to.

  “If there’s a way for me to help with a transition, help with clients, you know, I will do that,” Fuld offered.

  “I’ve always heard you were a good man,” Diamond told Fuld consolingly. “Now you’ve proven that.”

  After a twenty-minute crawl through traffic on the FDR Drive, Chris Flowers finally arrived at AIG’s offices just before noon. He was led to a meeting room where Willumstad, Schreiber, Steven J. Bensinger (the firm’s CFO), and a team of others were waiting. Schreiber immediately passed around a one-page summary of the firm’s cash outflows that was set up like a calendar: Each day from Friday through the next Wednesday was marked with various scenarios, depending on the outcome of Moody’s decision about its credit rating. If the executives hadn’t yet come to appreciate the full extent of the conundrum in which they now found themselves, Schreiber’s document put it into stark relief. By next Wednesday, the calendar indicated, the parent company would be negative $5 billion, with the shortfall each successive day only growing worse.

  Flowers’s eyes widened as he studied the numbers. “You guys have a real problem here.”

  “Yes. But we should be okay if we can make the capital raise work,” Willumstad said.

  “Have you guys thought about Chapter 11?” Flowers blurted out. It was as if he had touched the third rail.

  “Why are you using words like that?” Bensinger asked, clearly upset.

  “Um, I can assure you,” Flowers told him, “that if you don’t pay people $5 billion on Wednesday, they’re going to be really, really upset, so you can call it whatever you want, but they are not going to be happy if you don’t pay them on Wednesday.”

  Just then Jamie Dimon called back and was patched into the conference room’s speakerphone.

  Schreiber described the potential cash-flow problems and their plans to fix them. “I’ve begun putting together a process for the weekend,” he said, explaining how they’d reach out to possible suitors beginning that afternoon. He also walked
through the company’s various divisions and the amount of cash that each had on hand.

  Before Schreiber could continue with his inventory, Dimon cut him off. “You’re a smart guy but you’re running a fucked-up process.” The worst-case scenario that Schreiber was describing wasn’t anywhere near bad enough, Dimon insisted, and scoffed, “You guys have no idea what you’re doing. This is amateurish, it’s pathetic.”

  Even worse, Dimon didn’t think that they had an accurate read of their financial data. As far as he could tell, Schreiber was simply reading off a sheet of siloed information that had never been aggregated and analyzed in one piece.

  “You guys need to get a handle on the numbers,” he said. “The real numbers. You need to sit down with those numbers and figure out the size of the real hole, not the made-up hole. How big is the securities lending? You have to go contract by contract, like bottoms-up, real work. Then you need to make a list of who can help you fill it. This isn’t like, you know, you’re going to be late on your credit card bill.”

  Willumstad just stared at the speakerphone in silence. He knew this routine well from their days with Sandy Weill: This was Jamie the hothead. Better to shrug it off, Willumstad thought. The worst part of Dimon’s tirade, he knew, was that he might be right.

  As the AIG team awkwardly attempted to get the conversation back on a less hostile footing, Flowers suggested they call Warren Buffett. He didn’t know Buffett well, and the last time they had spoken, Flowers had tried to get him interested in buying Bear Stearns during that fateful weekend in March. In times of crisis—when a big check had to be written almost immediately—Buffett was the obvious man to turn to.