Too Big to Fail

by Andrew Ross Sorkin

  Dimon looked at Mack dumbfounded. “If we do that,” he said caustically, “how many hours do you think it would be before Fidelity would call you up and tell you it was no longer willing to roll your paper?”

  When Thain finally did call Ken Lewis, the conversation was brief and to the point—merely a discussion of the logistics of their meeting. Thain was concerned enough to get the details correct that he called Lewis back a second time to confirm which entrance of the Time Warner Center he ought to use.

  Before driving over to Lewis’s apartment, Thain met with Fleming at the firm’s Midtown offices to strategize. He made it clear to Fleming that the discussions were purely exploratory—and that he wanted to sell only a small stake in the firm, maybe up to 20 percent.

  “He’s not going to go for that,” Fleming warned. “Lewis is going to say that he wants to buy the whole company.”

  Thain opened the car door himself, making a beeline to the entrance. Ducking under the extended steel-and-glass awning, with its One Central Park address, he rushed solo up the South Tower to Lewis’s apartment.

  Lewis greeted Thain warmly in a room with striking views but one that revealed its status as a corporate apartment by the virtual absence of artwork or furniture.

  “Given all the events that were going on,” Thain said, once they settled themselves, “I am concerned about the impact on the market and on Merrill if Lehman were to go bankrupt.” He paused for a few seconds and then said bluntly: “I’d like to explore whether you’d have an interest in buying a 9.9 percent stake in the company and providing a large liquidity facility.”

  “Well, I’m not really very interested in buying 9.9 percent of the company,” Lewis shot right back just as directly. “But I am interested in buying all the company.”

  “I didn’t come here to sell the entire company,” Thain replied with a slight grin on his face, having not expected Lewis to be so aggressive.

  “That’s what I’m interested in,” Lewis repeated firmly.

  Thain nervously tried to forge a compromise. “Are you willing to go down two tracks, explore a 9.9 percent sale and explore a 100 percent sale?”

  “Yes,” Lewis agreed, “but remember that I said to you, I’m not really interested in 9.9 percent, I’m really interested in a full merger.”

  Lewis and Thain spent the next half hour reviewing the various mix of businesses, the strategic rationale for a merger, and assembling some due diligence teams. Lewis suggested they reconvene with “the two Gregs”—Greg Curl and Greg Fleming—at 5:00 p.m.

  “I can’t do it then,” Thain told Lewis.

  Strange, Lewis thought. Thain showed up wanting to do a deal and now he couldn’t meet in two hours? Did he have somewhere better to be? Was he in talks with someone else?

  As he was about to leave, Thain stopped and raised a final point: “I have to tell Hank about these conversations,” he explained, “because I’m worried that if Hank finds out about them, he’s going to think that I screwed up the Lehman deal.”

  “Well, look, you know,” Lewis answered, “I would prefer the Merrill deal. You can tell Hank that we’re having these discussions, because we’re not going to pursue Lehman without government assistance.”

  In the end, the men would separately brief Paulson, who, as it happened, was thrilled to hear the news. As far as he was concerned, Barclays was about to buy Lehman, and now Bank of America was talking about acquiring Merrill. It was all coming together.

  “I got voice-mail again,” a frustrated Fuld told Tom Russo. “Nobody’s picking up his goddamn phone!”

  He could not locate anyone he needed—Paulson, Geithner, Cox, Lewis. Even Bart McDade, his own employee, was unreachable. They were all down at the NY Fed, but no one was taking his call or calling him back.

  Fuld wanted an update. He had been in his office all of Saturday, dressed in a blue suit and starched white shirt as if it were a typical work day, but hadn’t heard a word about Bank of America or Barclays.

  When the phone did ring, it was Rodgin Cohen, who, calling from the NY Fed, said, “Yeah, we’ve got a problem. I think Merrill and BofA are talking.”

  “What do you mean?” Fuld barked.

  Cohen explained that he had just left a meeting with Geithner at which he tried to persuade him again that government assistance was necessary to avoid the collapse of the entire banking system. As Cohen recounted it, he had told Geithner: “If you don’t help, Merrill will be gone by Monday.”

  Geithner’s response—“We’re working on a solution for Merrill”—had been purposefully vague, but both Cohen and Fuld knew exactly what it meant. It also explained Bank of America’s silence. They both hadn’t forgotten Greg Curl’s comment to them over the summer about how Lewis had always wanted to buy Merrill. And it explained the odd phone call Cohen had received from Merrill’s Fleming earlier in the week, casting about for information.

  “I can’t even believe this,” Fuld said, sinking deeper into his chair.

  During some downtime at the NY Fed, Gary Cohn and David Viniar of Goldman Sachs greeted their former colleague Peter Kraus, who was now a week into his new job at Merrill.

  “Peter, come for a walk,” Cohn suggested, and all three men stepped out the front door onto Liberty Street.

  “So, what’s going on?” Cohn asked after they had gone a short way, hinting that he knew that Merrill was under enormous pressure—perhaps more so than anyone in the room.

  “We just have a liquidity problem,” Kraus said. “JP Morgan just upped our intraday margin lines by $10 billion.” He paused. “We’re fine, we’re totally fine.”

  “Peter, should we be looking at you guys?” Cohn asked.

  Kraus looked down before answering. “Yes.” Any deal with Goldman would not just shore up Merrill’s teetering financial position but also would be seen as a vote of confidence by the smartest guys in the room.

  “Why didn’t you say something?” Cohn asked. “We’ve been friends forever. We’ve been sitting next to each other for a day and a half.”

  As they strolled around the block, Kraus said that it would be worth having a meeting. He said that Merrill would be looking for a credit line to get over the hump of their liquidity crisis in exchange for selling a small stake in the company, probably under 10 percent. It was nearly the same arrangement that Thain had originally been seeking from Lewis.

  They agreed to meet the following morning at Goldman Sachs’ offices.

  The instructions were specific: Don’t use the main entrance of the New York Federal Reserve on Liberty Street; use instead the employee entrance on Maiden Lane and show your driver’s license to the security guards. Your name will be on a list; an escort will be waiting for you.

  Bob Willumstad of AIG and his advisers, Doug Braunstein of JP Morgan, Jamie Gamble of Simpson Thacher, and Michael Wiseman of Sullivan & Cromwell walked over from AIG’s headquarters to meet with Paulson and Geithner, strolling past the photographers and reporters, who, to the bankers’ relief, didn’t recognize them.

  “Where do you stand on the capital raise?” Geithner asked without preamble.

  Willumstad said that he believed that they were making progress. A half-dozen bidders were still at the building, including Flowers, KKR, and Allianz.

  But, Willumstad said, the bigger news—the good news—was that he had persuaded Eric R. Dinallo, superintendent of the New York State Insurance Department, to release some $20 billion in collateral from AIG’s regulated insurance entities, which would help it meet its capital requirement. Dinallo had made the agreement contingent on AIG’s raising another $20 billion to fill the hole. Willumstad intimated that he thought he had another $5 billion loan commitment coming from Ajit Jain, who ran Berkshire Hathaway’s reinsurance business. That left him with a $15 billion gap, but he told the regulators that the company had assets up for sale that were worth more than $25 billion.

  With that, Paulson and Geithner rose and abruptly left the meeting. They had heard all
they needed to; progress was being made.

  The doorman opened the cast-iron and glass doors to allow Thain, Kraus, and their colleague Tom Montag into the lobby of Walid Chammah’s apartment building. It was the second secret-merger meeting to take place there in one week. Thain was a little worried about being spotted: Among others, Larry Fink of BlackRock lived at the same address.

  Mack, Chammah, and Gorman were waiting for them in Chammah’s living room.

  Gorman, who had run Merrill Lynch’s private client business for five years before joining Morgan Stanley, was immediately struck by the fact that no one in the group representing Merrill had been with the company for more than ten months. The firm Gorman helped to build, and where his brother, Nick, still worked, was going to be sold out from under it by bankers with no sense of the firm’s heritage.

  Thain opened the discussion by indicating that he was looking to do a deal. “With what’s going on with Lehman,” he said, “we recognize this is the right time to look at our options.”

  Kraus began to go over the numbers, flipping through the pages of a book he had brought along with him. For someone who had only a few days on the job, Chammah and Gorman thought, he seemed to know his stuff. (Kraus had, in fact, stayed up till 3:00 a.m. earlier that week poring over the firm’s balance sheet.)

  But the gaps in his knowledge soon became apparent. When Gorman started asking him about Merrill’s retail business—the part of the company in which Morgan Stanley was most interested—neither Thain, Kraus, nor Montag knew the numbers.

  Still, Mack said he was interested and asked what the next step was. “We have a board meeting scheduled for Monday night,” he explained, “and Tuesday we could probably start diligence and take a look then. It’s obviously intriguing but this is complicated.”

  Thain gave Kraus an anxious glance and then turned to Mack: “No, no. You don’t understand. We would need to have a decision before Asia opens.”

  Gorman was confused: “What do you mean by ‘decision’?”

  “We’re looking to have a signed deal by then,” Thain said calmly.

  “We can keep talking,” Mack answered, shocked by the request, “but I don’t know that that’s physically possible.”

  After seeing themselves out of the apartment, Thain looked at Kraus and said, “Well, it’s pretty clear that they don’t have the same sense of urgency that we do.”

  Greg Curl of Bank of America was already at Wachtell, Lipton when Greg Fleming of Merrill Lynch arrived. While he waited, Curl had been on the telephone trying to undo his decision from four hours earlier: He had sent more than a hundred bankers back to Charlotte, assuming they were no longer needed, because as far as he had been concerned, the Lehman deal was dead. Now, with the possibility of a deal with Merrill, he needed them on the next plane back to New York. He recognized that the situation was almost comical and had assigned several people to coordinate looking into chartering flights, because the three remaining direct US Airways flights to New York that night were already full.

  Curl invited Fleming into one of the law firm’s conference rooms that he had commandeered, grabbing a handful of cookies from the catering cart that was parked there. He quickly asked him for his assessment of where he thought they were in terms of pursuing a deal.

  “I’m thinking we announce Monday morning,” Fleming said.

  “That’s very quick,” Curl replied, taken aback by the timetable.

  “You know the company really well,” Fleming answered. He was one of the few people who were aware that Merrill’s former CEO Stanley O’Neal had talked to Lewis about a merger, though he didn’t know all the details. “I know all the work you’ve already done. I’ll open up everything. Just tell me what you need.”

  For the next half-hour they drew up a process that would enable Bank of America to examine Merrill’s books within literally twenty-four hours. Curl, who dusted off the work he had done a year ago for the talks with O’Neal, said he was going to bring Chris Flowers in to advise him, as Flowers had recently looked into buying some of Merrill’s toxic assets over the summer (assets that were ultimately sold to Lone Star National Bank), so he would have a head start. Bank of America already even had a code name for the deal: “Project Alpha.”

  Before the meeting broke, the issue of price was raised. Fleming boldly declared that he was looking for “something with a 3-handle,” by which he meant $30 a share or more, which represented a 76 percent premium over Merrill’s share price of $17.05 on Friday. It was a shockingly high number, especially in the context of the greatest financial crisis of the firm’s history, but Fleming felt he had no choice: Merrill had just sold $8.55 billion of convertible stock a month earlier to big investors like Singapore’s state-owned Temasek, at $22.50 a share. He needed to get them a reasonable premium.

  For most bankers, a number that high would have stopped the talks in their tracks, but Curl understood the rationale behind the price that Fleming was seeking. Fleming argued that Merrill’s shares were temporarily depressed and that he needed a price that reflected a “normalized basis.” Just a year and a half ago, he reminded him, Merrill’s shares were trading at more than $80.

  Curl had a strong view about takeovers: You never want to overpay, but if you believe in the business, you’re better off paying more to guarantee you own it then to lose it to a competitor.

  “Okay,” Curl said, not committing to Fleming’s number, but clearly indicating that he wasn’t going to reject it altogether. “We’ve got a lot to do.”

  The weather was beautiful for a late Saturday-night dinner on the patio of San Pietro’s, the southern Italian restaurant on East Fifty-fourth Street off Madison Avenue. During the weekday the restaurant plays host to Wall Street bigwigs over lunch: Joseph Perella of Perella Weinberg, the dean of the M&A banking business, has a table there; other regulars include Larry Fink, chief executive of BlackRock; Richard A. Grasso, the former chairman of the New York Stock Exchange; Ronald O. Perelman, the chairman of Revlon; and David H. Komansky, the former chief executive of Merrill Lynch; and even former president Bill Clinton and his pal Vernon Jordan.

  Tonight Mack and Morgan Stanley’s management took a quiet table outside. For Chammah it was an opportunity to unwind and smoke a cigar. It had been a draining twenty-four hours.

  Gerardo Bruno, a big personality from southern Italy who owns the restaurant with his three brothers, showed the group to their table. Mack took his blazer off and threw it over the back of his chair. Soon, Paul Taubman, Colm Kelleher, and Gary Lynch met them there. There was a lot to talk about.

  After ordering a bottle of Barbaresco they launched into a postmortem of the grueling day, specifically the last crazy hour with Merrill Lynch, with Mack recounting the meeting with Thain for the benefit of those who hadn’t been in the room with him.

  “And then he says, ‘Can you do it in twenty-four hours?’” Mack reported as the table erupted in laughter.

  “No fucking way,” Colm Kelleher said.

  Once the laughter died down, Mack raised the biggest question before them: Given the scope of the crisis now enveloping the industry, did they need to do a deal?

  Chammah spoke up first. “Listen, there are not too many dancing partners out there that we want to dance with. If there’s ever going to be a time to talk, now’s probably the time.”

  Gorman stepped in and explained that Merrill Lynch, given their conversation just an hour ago with Thain, was likely to merge with Bank of America, perhaps within the next twenty-four hours. That meant that Bank of America would be taken off the table as a merger partner. Gorman was still shaking his head over the audacity of Thain, Kraus, and Montag’s attempt to sell Merrill, a firm they had only recently joined and hardly knew.

  “We could call Lewis,” Gorman suggested.

  Mack had always thought that Bank of America could be a natural merger partner for Morgan Stanley; indeed, before the crisis, he had often half-joked with friends that it was his “exit strategy.
” When his stock price was higher, he had often thought a deal with Bank of America would be one triumphant way of demonstrating that he had restored Morgan Stanley, the firm he loved, to its former glory. Strategically, they were a perfect fit: Bank of America was an outstanding commercial and retail bank, but its investment side was weak. Morgan Stanley had the opposite configuration: It was a superior investment bank but had few stable deposits. Perhaps the best part of the merger would be that Mack, born near Charlotte, where Bank of America was based, could retire there with his family as the new, combined bank’s chairman.

  But tonight, Mack understood, it wasn’t meant to be. “If Merrill goes to BofA, what do you think about Wachovia?” he asked as plates of Timballo di Baccala con Patate, Fave e Pomodoro arrived at the table.

  For the next two hours, they debated the merits of reaching out to Wachovia, also based in Charlotte; JP Morgan Chase; or HSBC. They could call China Investment Corporation, the nation’s largest sovereign wealth fund, Kelleher suggested, while Paul Taubman mentioned Mitsubishi.

  Whomever they might select, Mack was adamant on one point: “We shouldn’t be rushed into anything.” While it might be ugly out there, he reminded everyone of the obvious: They were Morgan Stanley, the global financial juggernaut. The firm’s market value was still more than $50 billion as of that Friday—a lot less than a month earlier but hardly a joke. And they had $180 billion in the bank.

  Kelleher, the bank’s CFO, had been diligently building up liquidity for months, in the event of just such a situation in which they now found themselves. There was no way there could be a run on Morgan Stanley; they had too much credibility in the market. At the same time, he recognized that if Lehman was sold to Barclays, and Merrill was sold to Bank of America, his firm would be in the hot seat.