Too Big to Fail

by Andrew Ross Sorkin

  Ruth Porat, a Morgan Stanley banker who was present at the Fed, also doubted the speculation, especially the price. She called John Pruzan, Morgan Stanley’s banking industry expert, to tell him the latest buzz.

  “The rumor is $29 a share, and it’s going to get announced in the morning,” she told him. “I can’t believe it, because they didn’t have time to do due diligence. It’s an absurd price.”

  Without missing a beat, Pruzan replied, “Then it’s absolutely Ken. It’s true. That’s what Ken does.”

  “Are you getting all this?”

  Gary Lynch, the chief legal officer of Morgan Stanley, was barking into the phone as Paul Calello, the chief executive of Credit Suisse’s investment bank, paced nearby. With no access to a computer at the New York Fed, Lynch was in the process of dictating the text of an important press release to Jeanmarie McFadden, a Morgan Stanley spokeswoman, who was typing frantically to keep up.

  The plan was to let the markets know that while Lehman might fail, Wall Street banks were cooperating to keep the whole financial system from imploding.

  The release would open: “Today, a group of global commercial and investment banks initiated a series of actions to help enhance liquidity and mitigate the unprecedented volatility and other challenges affecting global equity and debt markets.”

  It would go on to say that the world’s biggest financial institutions were creating a $100 billion borrowing facility for themselves—over and above what the Federal Reserve was providing though its Primary Dealer Credit Facility. Any one bank would be able to borrow up to $35 billion from the pool.

  So far, ten banks were lined up to provide $7 billion each, for a total of $70 billion. The individual banks were a Who’s Who of the global financial system: Goldman Sachs, Merrill Lynch, Morgan Stanley, Bank of America, Citigroup, JP Morgan, Bank of New York, UBS, Credit Suisse, Deutsche Bank, and Barclays. In normal times, many of them were the fiercest of rivals.

  The press release ended by stating assuredly that “the industry is doing everything it can to provide additional liquidity and assurance to our capital markets and banking system.”

  Panic was starting to build within the Lehman ranks. George H. Walker IV, head of the firm’s investment management unit, sat in his office at 399 Park Avenue, scrambling to find a way to save the division. He had received bids for it on Friday from two separate private-equity firms, Bain Capital and TPG, and was in the middle of trying to bring them together when he received a telephone call from Eric Felder, one of McDade’s traders.

  Felder was talking so fast that it sounded as if he were hyperventilating.

  “You have to call your cousin,” he insisted. “If there was ever a time to call the president, now is the time.”

  Walker, a second cousin to President Bush, was hesitant about using his family connections.

  “I don’t know,” he said.

  “You’ve got to do it, George,” Felder said to him. “The whole fucking firm is going down. Someone’s got to stop this!”

  He placed the call but ended up leaving a message with the White House operators. The call would go unreturned.

  With bankruptcy seemingly less than hours away, a new problem suddenly confronted Steven Berkenfeld, Lehman’s managing director: $18.5 million in unpaid bills from Weil Gotshal, the law firm he had hired to work on the bankruptcy filing. The debt, which was for previous legal work, was minuscule compared to the billions of dollars Lehman owed all over Wall Street. But it would prevent Weil and Harvey Miller from representing Lehman in Chapter 11. Since Weil was officially a creditor of Lehman, it would constitute a conflict of interest that a judge could use to throw Weil off the assignment.

  To Berkenfeld, it was critical that Weil be involved in the case. After all, its lawyers knew the firm the best, and Lehman’s filing was due in almost record time. For Stephen Dannhauser, Weil’s chairman, the assignment was also of paramount importance: Judging from the size and complexity of the Lehman filing, which promised to be even bigger than Enron’s, the fees were likely to be well over $100 million.

  Dannhauser had instructed Berkenfeld to pay Weil immediately, in advance of the bankruptcy, with cash sent by wire directly into the law firm’s accounts. Even this approach had risks: Being on the receiving end of such a payment could result in a law firm’s being disqualified from a case.

  Still, with all of the pressure Lehman was under, Berkenfeld made the effort.

  Because it was Sunday, there was only one place that the firm had cash available to wire—JP Morgan—and Berkenfeld had accordingly called over and made the request.

  But now Dannhauser had called to say that the transfer hadn’t gone through: JP Morgan had frozen Lehman’s account, a decision that, Dannhauser was told, “came from the top.”

  Berkenfeld immediately dialed JP Morgan’s general counsel, Stephen Cutler, and furiously demanded what it meant that the decision had “come from the top.”

  “Look, I don’t know what that means,” Berkenfeld said, his voice rising. “I don’t know if that’s Jamie Dimon or someone outside of the firm. But one day, we’ll take your deposition and find out what happened.”

  Cutler agreed he would try to make the payment.

  When Bob Diamond got back to his room at the Carlyle hotel, tired and deflated, he had a surprise waiting for him. His wife, Jennifer, and daughter, Nellie, a sophomore at Princeton, were there. Nellie, who had been scanning the news wires on her laptop, gasped when she read that the deal her father had been trying to broker had fallen apart and headed for New York.

  They decided to go for dinner at the Smith & Wollensky steak house. Just as they were approaching the restaurant Diamond’s cell phone rang. He looked down at the caller ID and saw that it was McDade.

  “I can’t answer it,” he told his daughter, who was puzzled by his uncharacteristic timidity. “I can’t do it anymore.”

  “Dad, answer your phone!” she insisted.

  Reluctantly, he took the call.

  “I’ve got a question,” McDade said immediately when he picked up. “If we go into bankruptcy, would you consider taking the U.S. broker-dealer out of bankruptcy?”

  Diamond whispered to Jennifer and Nellie, “I have to take this for a second.”

  As the women entered the restaurant, he asked, “Is that what’s going to happen? Is this going to be Chapter 11?”

  “We don’t know for sure,” McDade replied, “but if it goes into Chapter 11, if that’s the result, would you consider taking the U.S. broker-dealer?”

  “Bart,” Diamond told him, “that’s exactly the part we want. So absolutely. We would consider it. But I have to tell you, I know nothing about bankruptcy law and I don’t know where to start. I have to talk to my board, I have to talk to John, but I’m pretty sure our answer would be yes.”

  “Why don’t we do this,” Diamond continued. “I’ll get up early and get my team together, and we’ll meet you at five a.m. But leave me an e-mail if you haven’t declared bankruptcy. You get your team, and we’ll get our team.”

  Bob Willumstad, with his advisers from JP Morgan, returned to the Fed on Sunday night to offer the latest update.

  After Paulson, Geithner, and Jester took their seats around a conference table, Willumstad told the group somberly, “We’re in the same place, actually maybe a worse place than before.” He explained that the hole had since grown to $60 billion and detailed what they considered to be the “shenanigans” of Chris Flowers’s bid, to everyone’s amusement.

  Jester, taking notes, started to grill Willumstad and Doug Braunstein about the numbers. Jester didn’t understand why they kept talking in ranges; he wanted to know how much money AIG needed to the last decimal point.

  Braunstein sighed. “I can’t give you an exact figure. It’s difficult to get clear numbers,” he said, describing the antiquated systems at AIG.

  It was clear to everyone in the room that AIG was now, as Willumstad expressed it, “in a bind”—though no one
had as yet spoken of bankruptcy.

  Willumstad suggested, again, that the Federal Reserve loan AIG just enough money to avoid being downgraded by the ratings agencies.

  Geithner, again, said that that was out of the question. Given that Lehman was being left to die, Willumstad knew that Geithner’s refusal was serious. Still, he persisted.

  “I’m proposing a transaction, not a bailout,” Willumstad said. “If we just get the Fed’s backing in exchange for collateral, I give you my word I’ll sell every asset needed to pay you back.”

  Paulson repeated with exasperation that it wasn’t going to happen.

  Once the AIG team had left, Geithner told Paulson that they needed to start thinking about what they could do to rescue the company—perhaps via another private consortium?

  “I don’t know, I don’t know,” Paulson said wearily. He was still preoccupied with the fates of Lehman Brothers and Merrill Lynch, and now he was supposed to find a solution for AIG?

  Jim Wilkinson, Paulson’s chief of staff, trying to keep his boss’s spirits up, marveled, “This would be extremely interesting from an analytical perspective if it wasn’t happening to us.”

  Neither Treasury nor the Federal Reserve had oversight over AIG, but if it was going to fall to someone, it would be Geithner, who seemed closest to the situation. But before Paulson washed his hands of the situation, Geithner asked him if he could “borrow” the services of Dan Jester, who had proved to be quite helpful over the weekend working through many of the practical issues around Lehman and Merrill. As a former deputy CFO of Goldman, Jester understood financial services companies better than virtually all of them, Paulson said. And he was one of the few people among them who appreciated the complexities of the problem that lay ahead of them: When he was at Goldman, one of his clients back in the 1990s was none other than AIG.

  As the evening wore on, Jamie Dimon, now back at JP Morgan’s headquarters, rang Doug Braunstein for an update on AIG.

  “It’s not good,” Braunstein told him, referring to AIG’s growing hole as a “snowball.”

  Dimon understood that AIG might have immediate problems because of a “liquidity crisis,” but he continued to believe that there was enormous value in its underlying business. For a moment, he started to daydream. “Maybe we should be taking a look at it. There’s got to be value there. Got to be.”

  “What do you mean? For us?” Braunstein asked in disbelief.

  “Yeah,” Dimon replied.

  “No, no, no,” Braunstein insisted, trying to talk Dimon out of it. “They don’t seem to have a handle on their own numbers.”

  “I don’t know,” Dimon mused, still unconvinced that AIG could really be worthless. “It could be a good idea.”

  Paulson checked his watch and saw that it was past 7:00 p.m., which meant the Asian markets were opening, and Lehman still hadn’t filed for bankruptcy.

  “Has Cox talked to them yet?” he barked at his chief of staff, Jim Wilkinson.

  Wilkinson said that he had been trying to get Cox to call Lehman directly, but that he had been resistant.

  “He hasn’t done shit,” Wilkinson said dismissively. “I went in there and repeated what you said, and it’s like he’s frozen. Like a fucking deer in the headlights.”

  Cox, for whom Paulson had had very little respect to begin with, was proving how over his head he really was. Paulson had assigned him the task of coordinating Lehman’s filing by, well, now. “This guy is useless,” he said, throwing his hands in the air and heading over to Cox’s temporary office himself.

  After barging in and slamming the door, Paulson shouted, “What the hell are you doing? Why haven’t you called them?”

  Cox, who was clearly reticent about using his position in government to direct a company to file for bankruptcy, sheepishly offered that he wasn’t certain if it was appropriate for him to make such a call.

  “You guys are like the gang that can’t shoot straight!” Paulson bellowed. “This is your fucking job. You have to make the phone call.”

  The Lehman board had already begun its meeting when the bankruptcy lawyers from Weil Gotshal, towing wheeled suitcases stuffed with documents, finally arrived. Speaking in a subdued voice, McDade gave the directors a detailed account of what had happened at the New York Fed. He was answering their questions when Fuld’s assistant came in and handed a slip of paper to her boss, who began to slump in his chair as he read it.

  “Hold on a minute—sorry, Bart,” he blurted. “Chris Cox is calling and he wants to address us.”

  The board members looked at one another, their surprise etched in their expressions. No one could recall a time when the chairman of the SEC had asked to address a corporate board. One director questioned whether they should even take the call, but he was overruled. What did they have to lose? The lawyers, however, cautioned that if there were any questions, only the directors themselves should speak.

  Fuld leaned in toward the speakerphone and said in a weary voice, “Ah, Chris, this is Dick Fuld. We got your message, and, ah, the board is in session here, everyone is here, all the directors and the firm’s counsel.”

  A Lehman bankruptcy, Cox argued deliberately, stiffly, as if he were reading off a script, would help calm the market. It would be in the best interests of the nation, he said. He then introduced Tom Baxter, general counsel of the Federal Reserve of New York, who told the directors that the Fed and the SEC were in agreement that Lehman should file for bankruptcy.

  One of Lehman’s outside directors, Thomas Cruikshank, who had led the oil services company Halliburton through the 1980s oil bust before anointing Dick Cheney his successor as CEO, was the first to speak.

  “Why is it so important,” he asked, with a slight air of umbrage, “for Lehman to be in bankruptcy?”

  Cox repeated that the markets were in turmoil and that the government had taken everything into consideration. Others followed up with variations of that same query, but Cox and Baxter stayed on message. The directors grew increasingly and visibly frustrated by the vagueness of the two men’s answers.

  Finally, Cruikshank stated point-blank: “Let me see if I understand this. Are you directing us to put Lehman into bankruptcy?”

  For several moments there was silence on the other end. Then Cox said, “Ah, give us a few moments, and we will get right to you.”

  After one of the lawyers reached over the table and pushed the mute button on the speakerphone, the Lehman directors erupted with questions. Is the SEC telling us to file? Is the Fed? What the hell is going on here? To the best of anyone’s knowledge, the government had never ordered a private firm to declare bankruptcy, essentially hanging the Going Out of Business sign on the door itself.

  Ten minutes later, Cox, clearing his throat, got back on the line. “The decision on whether to file for bankruptcy protection is one that the board needs to make. It is not the government’s decision,” Cox said in the same steady, methodical tones. “But we believe that in your earlier meetings with the Fed, it was made quite clear what the preference of the government is….”

  John Akers, the former chief executive of IBM, interrupted. “So you’re not actually directing us?”

  “I’m not saying anything more than what I just said,” Cox replied before ending the conversation.

  The directors looked around at one another dumbfounded as Fuld sat impassively, his head buried in his hands.

  Tom Russo, Lehman’s chief legal officer, stood and outlined the board’s responsibilities under securities laws. As he spoke, some directors talked quietly among themselves. Bankruptcy seems inevitable. Do we file now? Next week?

  The government, they all knew, had plenty of leverage. If they did not do what Cox wanted, who knew what the consequences could be? The Fed, which had agreed to lend money to Lehman’s broker-dealer unit to allow it to fund trades, could just as easily close it and force Lehman into liquidation. There was a motion to vote on filing for bankruptcy.

  Henry Kaufman, an ei
ghty-one-year-old former Salomon Brothers economist who headed the Lehman board’s risk-management committee, haltingly stood up to speak. Known as “Dr. Doom” for his downbeat outlooks in the 1970s, Kaufman had been sharply critical of the Fed earlier in the year, accusing the central bank of “providing only tepid oversight of commercial banking.” Now he again took aim at the government for pushing Lehman into bankruptcy.

  “This is a day of disgrace! How could the government have allowed this to happen?” Kaufman thundered. “Where were the regulators?” He went on for another five minutes without stopping, and when he finally slumped into his seat the other directors could only look on in sadness.

  As midnight approached, the resolution to file was put to a vote and passed. Some of the directors had tears in their eyes. Fuld looked up and said, “Well, I guess this is good-bye.”

  One of the bankruptcy lawyers, Lori Fife, laughed. “Oh, no. You’re not going anyplace,” she said. “The board will be playing a pivotal role going forward.”

  Miller elaborated on her point: “You’re going to have to decide what to do with these assets. So it’s not good-bye. We’re going to be seeing each other for a while.”

  Fuld looked at the lawyers for a moment, dazed. “Oh, really?” he said softly, and then slowly walked out of the room, alone.

  Warren Buffett, just back in Omaha from Edmonton, had received word of Lehman’s pending bankruptcy before he arrived at the Happy Hollow Country Club for a late dinner with Sergey Brin, the co-founder of Google, and his wife, Ann.

  “You may have saved me a lot of money,” he said to the Brins with a laugh in the grand dining room. “If it wasn’t for getting here on time, I might have bought something.”

  Mayor Michael Bloomberg, who had been on the phone with Paulson, called Kevin Sheekey, his deputy mayor for government affairs, from his brownstone. “I think we have to cancel our trip to California,” he told Sheekey, who was already packing his bags for the high-profile event with Governor Arnold Schwarzenegger that he had been planning for months.