Too Big to Fail

by Andrew Ross Sorkin

  Trying to break the tension, Geithner now asked, “So what’s the latest?”

  Curl indicated in no uncertain terms that BofA was no longer interested in buying Lehman Brothers unless the government was prepared to help even more than they had asked for the day before. He said that they had identified at least $70 billion in problem assets that Bank of America would need guaranteed—the figure had grown from the $40 billion of a day earlier—and that it might be even larger. Given that, they were going to put their pencils down unless Paulson was willing to “step up.”

  Curl also said that he was concerned that Fuld was still seeking a premium for the stock. “We think that’s bullshit,” Flowers remarked.

  “You know, no one cares what they think. Don’t worry about what they think,” Paulson told them. “At this point, it doesn’t matter what Dick Fuld thinks.”

  In the middle of the meeting, Herlihy’s cell phone began ringing, and he saw that it was Fleming. After ignoring his first two calls, Herlihy whispered to Curl that it was Fleming and excused himself from the meeting.

  “What’s up?” Herlihy asked impatiently.

  “Okay. He’ll do the meeting at two thirty p.m.!” Fleming exclaimed.

  “Well, can you get Thain to call Lewis?” Herlihy asked.

  “Not now,” Fleming said. “Thain can’t speak to him because he’s in a meeting with Paulson.”

  Herlihy rolled his eyes. “No, he’s not, Greg. I’m in a meeting at the Fed with Paulson. I just stepped out of the room and can see him. He’s down the hall from me.”

  Herlihy was growing increasingly concerned that Fleming didn’t have Thain’s blessing, and repeated, “Listen, this isn’t going to work. He’s got to call. If I can step out to take your call, he can step out and call Lewis.”

  “He’s going to be there, I promise. I’m not risking my reputation by having Lewis fly up here and go to an empty meeting,” Fleming insisted.

  “He’s got to make the call,” Herlihy insisted again.

  By the time Herlihy stepped back into the room, it was clear that the meeting was winding down, and while the government was still refusing to become involved, Paulson was trying to keep Bank of America from dropping out altogether.

  As everyone stood up to leave, Chris Flowers pulled Paulson aside and said, “I’ve got to talk to you about AIG.” He paused to make certain they weren’t being overheard, and continued, “I’ve been over there working with them, and it’s just remarkable what we found.” He took out the same piece of paper that had been handed out the day before, showing the firm’s cash outflows and how by Wednesday it would be out of money.

  “Here’s how big the hole is,” Flowers said, pointing to the negative $5 billion cash balance coming due that next week. “AIG is just totally out of control. They’re incompetent!” Flowers offered to come back to the Fed with Willumstad to go over the numbers in more detail, and while Paulson was shocked at the numbers, he tried not to give Flowers the satisfaction of knowing how unnerved he was.

  When Flowers walked out of the meeting and rejoined the Bank of America team in the hallway, he smugly told them, “They’re not on top of it.”

  As Paulson, Geithner, and Jester reassembled in Geithner’s office, Jester stressed that they had to somehow keep Bank of America “warm” so that it remained in the auction. And if Bank of America had dropped out, it had to be kept quiet—especially from Barclays.

  Paulson, however, was focused on the AIG document that he had just seen, doing the math in his head. “It’s much worse than I thought,” he finally said. “These guys are in deep doo-doo.”

  Geithner reached Willumstad on speakerphone and told him that they had just met with Chris Flowers, who had walked them through the numbers.

  “He’s looking at buying some assets, putting together a deal,” Willumstad responded, and for a moment the confused government officials all looked at one another: Wasn’t Flowers advising AIG? But then Jester smiled knowingly at Paulson. This was classic Flowers, playing both sides. It quickly became evident to everyone that Flowers was likely trying to tee up a deal for his buyout shop with government assistance. “He’s frankly a troublemaker,” Paulson exclaimed. “He doesn’t want to save this country!”

  The discussion returned to the numbers, and Willumstad explained that they had teams of bidders at his office and were hoping to sell enough assets over the weekend to cover the pending shortfall.

  Geithner suggested Willumstad come over later that day to review the firm’s books and so that they could get a better handle on what its plans were.

  “Okay,” Willumstad said. With a laugh, he added, “I won’t be bringing Flowers.”

  Downstairs the CEOs were now summoned from the dining room to the conference room to deliver a progress report to Paulson and Geithner.

  Each of the groups offered up what they had accomplished, which amounted to very little. Part of the problem was that there was still huge disagreement over what Lehman’s assets were actually worth, especially its notorious commercial real estate assets. While Lehman had been valuing that portfolio at $41 billion, consisting of $32.6 billion in loans and $8.4 billion in investments, everyone knew it was worth far less. But how much less?

  One set of estimates making the rounds was a spreadsheet called “Blue Writedowns” that cut the estimated value of Lehman’s commercial real estate loans by about one quarter, to less than $24 billion. Others thought the situation was much worse. A handwritten sheet with more estimations making the rounds had the numbers “17–20”—less than half the estimated value.

  The story was much the same with residential mortgages, which Lehman had estimated at $17.2 billion. While the Blue spreadsheet placed the value at about $14 billion, others in the room put the real value at closer to $9.2 billion, or roughly half.

  But Pandit had another issue to raise: He wanted to talk again about AIG. And then he added: “What about Merrill?”

  It made for an awkward moment, as John Thain was only seats away.

  “You guys get this done for me, and I’ll make sure I can take care of AIG and Merrill,” Paulson replied. “I’m a little uncomfortable talking about Merrill Lynch with John in the room.”

  Harvey Miller, Lehman’s bankruptcy lawyer, had just had a terrible meeting with representatives of the New York Fed. He couldn’t answer any of their questions, and frankly, he was embarrassed at having continually to resort to the same answer: “We don’t have access to information. Everybody at Lehman is either working on Bank of America or Barclays.” After they left, Miller complained to his colleague, Lori Fife, “That was bullshit.”

  Miller had dealt with tough clients before—bankruptcy was always a parlous transaction—but he had never been shut out like this. When he called Steve Berkenfeld, Lehman’s general counsel, to complain, Berkenfeld tried to explain why the information had not been as forthcoming as he had hoped. “The problem is that many of our financial team have gone downtown to give an update to the Fed.”

  “I see,” replied Miller frostily. “And what is the latest with Barclays?”

  “We’re still hopeful, but there’s not much new to report at this moment.”

  “And with BofA?”

  Berkenfeld paused before answering. “They’ve gone radio silent.”

  That didn’t sound very encouraging to Miller, who had developed a keen ear for detecting a tone that indicated the end was near. His team of lawyers had been operating on the assumption that the bankruptcy work was a contingency; no one was expecting Lehman to have to make a filing immediately. But as the clouds over the firm grew darker, Miller decided to move forward. He told Fife that if Lehman were to need to file for bankruptcy, it would take them at least two weeks to get the paperwork in order. They might as well begin now.

  Just after noon he sent out an e-mail to a handful of colleagues with an apocalyptic subject line: “Urgent. Code name: Equinox. Have desperate need for help on an emergency situation.”

&nb
sp; Thain was in the middle of a conversation strategizing with Peter Kraus when Fleming called.

  “I’ve set it up,” Fleming told him excitedly. “You’ll meet with Lewis this afternoon.”

  Thain knew that the meeting was a good idea, but there was one complication: “Paulson’s not going to like this,” he warned Fleming. A merger, he thought, would be a death sentence for Lehman, as he’d have stolen Lehman’s sole potential savior. He didn’t know that Bank of America had dropped its bid for Lehman.

  “Paulson’s constituency is the taxpayer,” Fleming responded. “Ours is Merrill Lynch shareholders. Paulson has the ability to step in. We’re going to have to listen to him, but we don’t have to anticipate that. He may not like it, but unless he tells us we can’t do it, if we think this is in the best interest of Merrill Lynch shareholders, we need to do it.”

  Thain still hesitated, wanting to make certain that he wasn’t putting the company into play.

  “I’ve set the meeting for two thirty p.m.,” Fleming pressed, and then carefully added, “But you have to call Ken first.”

  “Why?” Thain asked, perplexed at the request.

  “Because he wants to hear your voice,” Fleming answered.

  “What do you mean?”

  “I don’t know, just tell him the weather is nice in New York and you’re looking forward to seeing him.”

  “I don’t understand why I need to make the call,” Thain persisted.

  “John, you just have to call him.”

  “You’re getting on my nerves,” Thain said, annoyance straining his voice.

  “You know what? That’s probably going to happen again this weekend,” Fleming said, raising his own voice to his boss for the first time. “But call the guy. He’s not going to fly until you call him.”

  “Okay,” Thain agreed. They decided that they’d both meet at Merrill’s Midtown office in thirty minutes to plan for the meeting.

  Soon after Thain hung up with Fleming, John Mack walked over to him.

  “We should talk,” Mack said quietly. He didn’t have to elaborate—the phrase was accepted code for, We should talk about doing a deal together.

  “You’re right,” Thain said, and they agreed to organize a meeting later that day. It was becoming a busy day.

  On the fourth floor of the Fed, Bob Diamond of Barclays was tapping his foot impatiently.

  For most of the morning, it seemed to him that Lehman and the government were exclusively focused on Bank of America. He had come to suspect that he was being used, that he was the government’s stalking horse so that they could coax out a higher bid for Lehman from Bank of America.

  But then, just past 2:00 p.m., Diamond had an indication that his bid might be taken seriously when someone at the Fed taped a piece of paper on Barclays’ conference room door that said “Bidder.” The Fed’s kitchen staff had also finally shown up with food. All small gestures, but encouraging signals, nonetheless.

  Still, Diamond knew he had a big problem to deal with before a Lehman deal could take place—a problem that he had yet to share with Paulson or anyone in the U.S. government. His general counsel in London, Mark Harding, had informed him on an internal conference call that morning that if Barclays were to announce plans to acquire Lehman, the deal would require a shareholder vote—a vote that might take as long as thirty to sixty days to complete. That meant that it would be critical that Barclays find a way to guarantee Lehman’s trading from the time they signed the deal until it was approved by its shareholders—or the acquisition would be worthless. Without the guarantee, Lehman’s trading partners would stop doing business with it, swiftly draining its resources and destroying any value for Barclays. This was about confidence: Counterparties needed to know that there was someone standing behind Lehman in the same way that JP Morgan had stepped up to the plate for Bear Stearns and guaranteed all of its trades even before the deal closed. The problem was that legally Barclays could not guarantee any more than about $3.5 billion of Lehman’s trades without seeking permission from shareholders first, a process that could take as long as completing the deal.

  Paulson and Geithner had repeatedly told Diamond in no uncertain terms that the U.S. government was not going to help, but he hadn’t been able to determine if that was just a negotiating stance. As for the British government, there was no mystery there to him: It was perfectly clear that it wouldn’t get involved.

  What Barclays needed was a partner—a big, rich one—and it was a matter that Diamond knew he had to discuss with his brain trust, which was led by Archibald Cox Jr., Barclays Capital’s chairman (and the son of the Watergate prosecutor), Rich Ricci, the firm’s COO, and Jerry del Missier, Barclays Capital’s co-president. Diamond had also hired his own outside adviser, Michael Klein, a smart former senior banker at Citigroup. Klein had resigned from Citigroup months earlier rather than be marginalized by Pandit’s new team, but he was still a hot commodity. To keep him from going to work for a competitor, Citigroup had agreed to pay him out $28 million in deferred compensation that he would have lost by leaving. In exchange, he had to stay “on the beach” for an entire year. Diamond, convinced he needed Klein on his side, had called Pandit earlier in the week to get his on the beach status temporarily suspended so that he could work for Barclays on an emergency basis.

  As they began brainstorming about the trading-guarantee problem, Klein asked aloud, “Who could possibly do this?”

  “This is the kind of thing that, a year ago, you’d go to AIG, and they would have wrapped this for you, right?” del Missier asked.

  That clearly was no longer possible, and Klein offered, “What about Buffett?” “Yeah, but Buffett only does deals if it’s a fantastic deal for Buffett,” del Missier pointed out.

  Klein had done some deals with the Omaha Oracle when he was at Citigroup and had all his phone numbers. He called and found Buffett at the Fairmont Hotel Macdonald in Edmonton, Alberta, as he and his second wife, Astrid Menks, were about to leave for a gala, unbeknownst to them, as the surprise guests.

  Klein put him on speakerphone with Diamond and his team. Del Missier began to explain to Buffett why the guarantee was so important. “If Lehman trades dollars for yen with somebody, that bank needs to know that Lehman is going to deliver the dollars before they deliver the yen,” he told Buffett. “If there are worries that they’re going to be able to settle that trade, the whole thing is going to unravel.”

  Buffett understood what was at stake but couldn’t fathom guaranteeing Lehman’s books for up to two months. But wanting to be polite, he suggested, “If you fax me something written out about it, when I get back, I’ll be glad to read it.”

  As he shut his cell phone and strolled to his car on the way to the gala, Buffett remembered the last time he had received a call like this. What a mess that turned out to be. In 1998, the week before the rescue of Long-Term Capital, Jon Corzine of Goldman Sachs called asking if he’d consider joining a group interested in buying the giant, troubled hedge fund. Buffett was about to leave on a trip to Alaska with Bill and Melinda Gates, so he asked Corzine to send him some information on that deal. Then he ended up spending a day trying in vain to get his satellite phone to connect while he viewed grizzly bears in Pack Creek. He tried to orchestrate a deal between himself, Goldman, and AIG, but failed. It was a big waste of time and energy. Maybe he had to stop being so polite to these Wall Street boys.

  Downstairs at the New York Fed, the CEOs and their underlings had all begun milling around the lunch buffet tables. Despite the grave assignment they’d been given, there was little they could actually accomplish on the spot. Not only did they not have computers with them, but the people with any real expertise in analyzing balance sheets and assets were either with the Lehman team upstairs or back at their offices, poring over volumes of spreadsheets.

  In one corner a number of executives, trying to pass the time, were doing vicious imitations of Paulson, Geithner, and Cox. “Ahhhh, ummm, ahhhh, ummm,” one banker mu
ttered, adopting Paulson’s stammer. “Work harder, get smarter!” another shouted, mocking Geithner’s Boy Scoutish exhortations. A third did his best impression of Christopher Cox, whom they were all convinced had little understanding of high finance: “Two plus two? Um—could I have a calculator?” In another corner, Colm Kelleher, Morgan’s CFO, had begun playing BrickBreaker on his BlackBerry, and soon an unofficial tournament was under way, with everyone competitively comparing scores.

  After lunch, they were all summoned back into the main conference room, where John Thain’s absence did not go unnoticed.

  If there was one topic besides Lehman’s future on the minds of the CEOs, it was the fate of their own firms. What would Lehman’s bankruptcy mean for them? Was Merrill really next? What about Morgan Stanley or Goldman Sachs? And what about JP Morgan or Citigroup? While commercial banks like JP Morgan had large, stable deposit bases, they still funded part of their business the same way the broker-dealers did: by regularly rolling over short-term commercial paper contracts that had become subject to the same erosion of confidence that had brought down Bear Stearns—and now Lehman Brothers. To them the waning trust only suggested the nefarious handiwork of short-sellers.

  At one point, John Mack questioned the whole idea of bailouts and ruminated aloud about whether they should just let Merrill fail, too, even though seated just a few places away from him was Peter Kraus, who was standing in for John Thain. The question quickly quieted the room. Some thought he was gaming all of them—maybe he wanted to buy Merrill on the cheap? What they didn’t know was that he had approached Thain just hours earlier and had set a meeting for that evening.