Too Big to Fail

by Andrew Ross Sorkin

  Thain picked up Fleming’s call just as his SUV was winding down Maiden Lane and about to enter the underground parking lot at the Fed Building. A half-dozen photographers had already camped out and were snapping away.

  “This is our time to move,” Fleming insisted. “We don’t even necessarily have to do the deal, but we should at least examine it now, and we should see if we can put it together.

  “We should use the weekend to do that,” Fleming pressed on, before Thain could interrupt him. “We shouldn’t try to do this potentially under duress next week.”

  As a longtime deal maker, Fleming certainly knew how valuable even a weekend could be. The biggest deals on Wall Street had always been finalized when the markets were closed on Saturday and Sunday, so that the details could be refined without worrying that a leak could quickly affect stock prices and potentially scuttle an agreement.

  Thain still counseled patience. “If Lehman doesn’t make it, if they file for Chapter 11, Bank of America will still be there,” he told Fleming. But he assured him: “I hear you loud and clear. I’m keeping an open mind, and if we need to make the call, we’ll make the call.”

  That was all Fleming needed to hear. He was making progress.

  By 8:00 a.m., the grand lobby of the New York Federal Reserve was teeming with bankers and lawyers. They had gathered not far from a giant bronze statue of young Sophocles, his outstretched arm holding a tortoiseshell-and-horn lyre. The statue was a symbol of victory after the Battle of Salamis, a clash that saved Greece and perhaps Western civilization from the East. On this day the bankers assembled at the Fed had their own historic battle to wage, with stakes that were in some ways just as high: They were trying to save themselves from their own worst excesses, and, in the process, save Western capitalism from financial catastrophe.

  An hour later the group shuffled into the same boardroom at the end of the corridor where they had sat, mostly shell-shocked, the night before.

  By morning they had settled on the working groups: Citi, Merrill, and Morgan Stanley were put in charge of analyzing Lehman’s balance sheet and liquidity issues; Goldman Sachs, Credit Suisse, and Deutsche Bank were assigned to study Lehman’s real estate assets and determine the size of the hole. Goldman had had a jump start as a result of its mini–diligence session earlier in the week, and both Vikram Pandit and Gary Shedlin of Citigroup were so nervous that Goldman would try to buy the assets themselves on the cheap that they attached themselves to their group.

  “As you know, the government’s not doing this, you’re on your own, figure it out, make it happen,” Geithner said. “I’m going to come back in two hours; you guys better figure out a solution and get this thing done.”

  His tone struck many in the room as patronizing if not ridiculous. “This is fucking nuts,” Pandit said to John Mack; it was as if they had all been handed a test without the customary number 2 pencils.

  Lloyd Blankfein raised a question: “Tim, I understand what you want to do, but how do I get in the other room?” In other words, he wanted to know how he could become a buyer subsidized by his competitors. Blankfein wasn’t serious—he had no interest in buying Lehman, but he was clearly trying to make a point. Why are we helping our competition?

  Geithner deflected the question and left the room, followed by the bankers, who were simultaneously daunted and deflated.

  Thain, Peter Kraus, and Peter Kelly of Merrill found a corner to talk in.

  “So, what do you think?” Kelly asked.

  “Lehman’s not going make it,” Thain said.

  “Then we’re not going to make it either,” Kelly replied calmly.

  “We have to start thinking about options,” Kraus said.

  Thain nodded in agreement. Maybe Fleming was right after all.

  Thain dialed Fleming and, after telling him about the conversation, said: “Set up the meeting with Lewis.”

  Upstairs, on the seventh floor of the Fed, Lehman’s Bart McDade and Alex Kirk felt a little bit like mail-order brides as they waited to meet the bankers from the firms that they hoped would save them. This, they knew, would be the ultimate “road show.”

  They had brought binders of materials, including what were perhaps the two most important documents, known as decks. One described the spin-off that Lehman referred to as REI Global; the other was labeled “Commercial Real Estate Business Overview”—in other words, the worst of the worst holdings, the toxic assets that no one knew precisely how to value and that everyone was nonetheless certain that Lehman was overvaluing.

  Even now Lehman seemed to be in denial: The decks revealed that it had marked down the value of its commercial real estate assets by an average of only 15 percent. Most Wall Street bankers had already assumed the reduction would be far greater.

  “Okay, let’s just make sure you and I agree exactly on all of these issues and how they’re financed,” McDade said to Kirk. They reviewed each line in order: how the balance sheet was broken down by liabilities, their derivatives, receivables, payables, repo lines, and long-term debt.

  If they were confused about any given detail, McDade phoned Ian Lowitt, who was a veritable financial encyclopedia. “He should be the one down here,” McDade blurted during one of his explanations of an especially obtuse passage.

  As they completed their preparations, Steve Shafran, Hank Paulson’s top lieutenant, phoned and instructed the two men to go and meet their possible saviors. A security guard escorted them downstairs to the main dining room, where several dozen bankers waited. Wall Street’s most elite firms were effectively about to go shopping in the equivalent of a government-sponsored Turkish bazaar.

  The Lehman executives were seated at a table in the farthest corner of the huge room, where everyone stopped to look—to gawk, in fact. “Do you know what this is like?” Kirk asked McDade when they were finally settled. “We’re the kid with the dunce cap in the corner!”

  McDade let out a big laugh just as a group of bankers they did not know from Credit Suisse wandered over, flashing wide grins, and started eyeing them. “What’s going on?” one of them asked. Kirk rolled his eyes in a way that clearly indicated, Please, do not mess with us. “What the fuck do you think is going on?” he replied. Before things could get too ugly, the cream of Wall Street suddenly appeared: Vikram Pandit, John Mack, John Thain, and Peter Kraus came over to the table and got down to business. Mack, who had met McDade at his home over the summer when they had considered merging, struck a sympathetic note: “Oh, god, I feel awful for you guys. This is just terrible.” Thain sat quietly, sipping a coffee, with every reason to think, This could be me. McDade pulled out his documents and began walking them through the numbers. As Kraus began to question some of the assumptions, Pandit stopped him. “Okay, okay,” he said, impatiently waving his hand in the air. “You have a homework assignment,” he told the Lehman bankers. “Give me a full business plan on how you would run this thing, so we can consider whether we’re going to finance it. You have two hours to complete it.”

  Five minutes later a security guard came over to McDade and Kirk and told them, “We’re going to take you up to another floor so you can work.” The Fed had hoped to provide them with an actual conference room, but because there wasn’t any space available, they were escorted to the Fed’s medical center, where a makeshift office had been prepared. It was, if nothing else, all too apt a metaphor, as the Lehman executives immediately realized. Kirk looked at the defibrillator on the wall and deadpanned, “Well, this is appropriate. We’re clearly the heart attack victim.”

  Greg Curl and Joe Price of Bank of America were on their way downtown with their lawyer, Ed Herlihy, for a 10:00 a.m. meeting with Paulson and Geithner. They had by now resolved not to pursue a deal with Lehman; Curl had already sent some of his people back to Charlotte.

  Before they arrived, Herlihy’s cell rang; he could see from the caller ID that it was Fleming. For a moment, he hesitated answering.

  Before they had left, the group had dis
cussed what to do if Fleming called again. Chris Flowers had advised Curl, “Let’s not waste another fucking minute on this until John Thain himself calls Ken Lewis and says the words out of his own mouth: ‘I want to do this deal.’ Otherwise, it’s just a bunch of bullshit.”

  Exasperated, Herlihy finally answered the phone.

  “We’re going to make this happen,” Fleming said excitedly. “John says we should set it up.”

  Herlihy had heard this before and had grown tired of the routine.

  “Greg, I’ve said it once and I’ll say it again: We’re not doing this without being invited in. I’m actually in the car with Greg Curl now. I’ll put him on. He’ll tell you we’re serious about that.”

  “Listen, we’re interested,” Curl said after being handed the phone. “But we do need to hear from Thain directly on this.”

  “Okay, okay,” Fleming told him. “I’ll call you back.”

  For all their interest in acquiring Merrill Lynch, Curl, Price, and Herlihy had reason to be wary of Fleming’s overtures. The three men knew something that no one else knew, a bizarre turn of events that had never leaked out—and thank god for that, they thought to themselves, for it would have left them the laughingstocks of Wall Street.

  Ken Lewis had, in fact, already been through this dance with Merrill Lynch a year ago almost to the week with Stan O’Neal. No one outside of O’Neal and a handful of BofA executives even knew the talks had taken place, and not even Merrill’s or Bank of America’s board had been informed of them.

  On the last Sunday of September, O’Neal had driven down to Manhattan from his weekend home in Westchester to meet with Lewis at his plush corporate apartment in the new Time Warner Center. The meeting had been set up by Herlihy, who had acted as an intermediary. O’Neal showed up alone, though—Lewis had brought Curl with him.

  As a precondition of the meeting, O’Neal had indicated that he wanted $90 a share for Merrill Lynch, a substantial premium over its then stock price of slightly more than $70 a share. Lewis and Curl got right down to business, handing O’Neal a bound presentation of what a combination of Bank of America and Merrill would look like from a numbers and operational standpoint. As Lewis went through the proposal and was ready to start a discussion, O’Neal jumped out of his chair, excusing himself to go to the bathroom. After what felt like twenty minutes, as Lewis and Curl waited anxiously for him to return, they wavered between concern for O’Neal’s health and frustration that he seemed to have vanished.

  Finally, O’Neal returned, as if nothing unusual had occurred. Lewis shrugged it off and continued going through the presentation. As he continued, O’Neal stopped him.

  “Look, if we’re going to do a deal, it’s going to have to be at a reasonable premium,” O’Neal said, raising the price he wanted for the firm to $100 a share. “I’ve done some subsequent analysis and thought about it more,” he said, explaining how he justified the higher price by a sum-of-the-parts analysis of Merrill’s asset management, retail, and investment banking businesses.

  The number took Lewis aback. At first he almost ended the conversation. But then he allowed that he would continue the talks, but suggested if O’Neal wanted more money, “it would require more cuts.”

  “How much cost reduction do you have baked into the numbers that you have?” O’Neal asked.

  Lewis’s presentation projected $6 billion in cuts over two years.

  To O’Neal that was a huge number, even for someone who had been famous for his own cost cutting. And if he wanted $100 a share, it would be even more.

  O’Neal asked, “So, how would you see me fitting into this?”

  “Well, you’d be part of the management team, but I haven’t really thought about a structure,” Lewis told him.

  That answer clearly was unsatisfactory. If they were going to have to reduce costs by as much as Lewis was saying, O’Neal said, he’d want to be the president of the firm so that at least somebody would be looking out for the Merrill employees. Lewis now became angry. “So, what you’re sayin’ is, you want me to sell out my management team to get this deal done for your benefit?”

  For a moment O’Neal only stared down at his feet, until finally saying, “I appreciate you spending the time. I appreciate the presentation and the thought that went into it. I’ve always thought that, on paper, that if Merrill were to do a strategic merger you are the most compelling partner.” As he turned to the door, O’Neal said, “I’ll think about everything you said.”

  Lewis never heard from him again.

  What he didn’t know was that the next day O’Neal confided in Alberto Cribiore, a Merrill board member, that he had gone to see Lewis, and told him about the meeting. Cribiore, always a good proxy for the rest of the board, was clearly not receptive to the merger idea, quickly brushing it aside,

  In his heavy Italian accent, Cribiore said, “But Stan, Ken Lewis is an asshole!”

  The sixteenth floor of AIG was already a beehive of activity, with hundreds of bankers and lawyers roaming the floors, darting into the various rooms that had been set up to perform due diligence on different AIG assets up for sale.

  Before the high-end tire-kickers arrived, Douglas Braunstein of JP Morgan, fresh off a conference call with Dimon, pulled Bob Willumstad aside to confide, “You need to think about more than the $20 or $30 billion we were talking about before, because Lehman could go bankrupt this weekend.”

  “The market’s going to be bad,” Braunstein warned. “We should probably be thinking about $40 billion.”

  Willumstad was flabbergasted; the challenge he faced had almost immediately doubled in size.

  A minute later, Sir Deryck Maughan, the former head of Salomon Brothers emerged from an elevator. Maughan—who was working for KKR, one of the bidders in the AIG fire sale—and Willumstad had known each other well but hadn’t been in touch for years. The last time they had seen each other was in 2004, when Maughan was being fired by Charles Prince, literally in Willumstad’s presence. It was Maughan, too, who had snubbed Steve Black’s wife on the dance floor more than a decade ago, resulting in a confrontation with Dimon, and his eventual ousting by Sandy Weill.

  And now, on a weekend when the entire financial system hung in the balance, Willumstad, Dimon, and Black were all looking to Maughan for help. Ah, Willumstad thought as he greeted Maughan with a wide smile, life is rich with irony.

  A few minutes earlier David Bonderman of Texas Pacific Group, one of the wealthiest private-equity moguls in the nation, had arrived with his own team. Bonderman, who was known for turnarounds, thanks to successful projects like fixing Continental Airlines, had also become increasingly leery of financial companies. He had acquired a $1.35 billion stake in Washington Mutual in April 2008 and watched his investment lose virtually all of its value in less than half a year.

  Willumstad was becoming increasingly anxious that all these bidders were there to suck AIG dry.

  Perhaps sensing Willumstad’s anxiety, Dr. Paul Achleitner, a board member of the insurance giant Allianz who had cut short his vacation in Majorca, Spain, to fly in for the diligence session, approached him.

  “Can I see you privately?” he asked.

  “Sure,” Willumstad replied.

  Achleitner had been invited to the diligence session by Chris Flowers, who had chartered a plane to fetch Achleitner and bring him across the Atlantic.

  Willumstad and Achleitner found a quiet corner.

  “I want you to know that I’m not here with all these vultures,” Achleitner said, pointing at the scrum of private-equity investors swirling about. “I’m here as Allianz. If we’re going to invest, we might invest alongside them, but we’re going to make our own decision.”

  “Thank you, I appreciate that,” Willumstad said, before returning to the vultures.

  Willumstad and the AIG team were quickly having a difficult time keeping track of everyone in the growing crowd and, as the weekend wore on, whom they actually represented.

  When Chris
topher A. Cole from Goldman Sachs appeared with a small army of bankers, John Studzinski, AIG’s banker from Blackstone, became alarmed. Goldman? Who invited them?

  “Who are you working for?” Studzinski asked Cole. At first Cole seemed oddly reticent to say. “Well,” he said, “we have several clients here.” Studzinski just stared at him, hoping to hear more. As they spoke, Richard Friedman, who ran Goldman Sachs’ private investment business, walked by, which did not go unnoticed by everyone else in the room. Was Goldman actually there for itself? “We’re here,” Cole started speaking again, “working with Allianz, Axa, and Goldman Sachs Capital Partners.” It was all so confusing and conflicted.

  Skeptical about the answers he was getting, and perhaps a bit paranoid, Studzinski raced up to the senior security guard on the eighteenth floor, Nathan T. Harrison. “Listen,” he told him, “I want you to watch all these people like a hawk. If you see anything untoward, anything at all—people walking around the wrong floors, whatever—come find me immediately.”

  Without a minute to spare the Bank of America team, which included Greg Curl, Joe Price, and Ed Herlihy, marched into the Fed building for their 10:30 a.m. meeting with Paulson and Geithner. Christopher Flowers had raced over on foot from AIG, two blocks away.

  As they waited in a conference room outside Geithner’s office, Curl recounted to the group how Fuld had been phoning Lewis’s home all night.

  “Dick…what an asshole!” Flowers said dismissively.

  As Paulson, Geithner, and Dan Jester entered the room, the mood quickly turned chilly. Paulson hated Flowers, and the antipathy was mutual. They had been feuding for years, ever since Paulson passed over Flowers for the top job of running Goldman’s investment banking division back when the firm was planning to go public. Flowers—who was given to telling his peers that Paulson was an “idiot”—quickly left the firm. Paulson told him that his decision to quit, coming as it did at the critical time of the IPO, was a “disgrace.” Flowers was bought out of the partnership ahead of the offering, but when the IPO was canceled, he made overtures about trying to return to the firm. That conversation had ended in a near-shouting match.