Too Big to Fail

by Andrew Ross Sorkin

  “The world is about to end tomorrow,” Bloomberg explained, without a hint of sarcasm.

  “Are you sure you want to be in New York for that?” Sheekey deadpanned.

  Peter G. Peterson, co-founder of the private-equity firm the Blackstone Group and the former CEO of Lehman in the 1970s before being ousted by Glucksman, was watching television with his wife, Joan Ganz Cooney, when she passed him the phone. It was a New York Times reporter asking him to comment on the day’s events.

  After pausing for a moment to take it all in, he said: “My goodness. I’ve been in the business thirty-five years, and these are the most extraordinary events I’ve ever seen.”

  Christian Lawless, a senior vice president in Lehman’s European mortgage operation in London, still at the office, e-mailed his clients Sunday night with a final signoff:

  Words cannot express the sadness in the franchise that has been destroyed over the last few weeks, but I wanted to assure you that we will reappear in one form or another, stronger than ever.

  At Wachtell Lipton, Ken Lewis, of Bank of America, had a wry smile on his face. “Wow!” he exclaimed.

  The deal with Merrill had been concluded—both boards had approved it—and he was waiting to share a champagne toast.

  But reaching the deal was not what he now found so amusing. Out of the blue, Stan O’Neal, Merrill’s former CEO, had sent an e-mail message to Herlihy that he read aloud: “I deeply regret my inability to convince the Merrill board a year ago,” O’Neal wrote, referring to their secret talks last September. Then he followed up: “While I would expect the answer is no, I would offer my advice and counsel to Ken Lewis Re: Merrill.”

  That e-mail was perhaps the only moment of levity in an atmosphere that had grown increasingly sour. Lewis had grown frustrated waiting around for the lawyers to finish with the deal documents so that he could sign them.

  Lewis himself hadn’t gotten involved in the specific details, but the merger agreement contained a handful of “side letters” and separate agreements covering compensation that seemed to be taking some extra time for the lawyers to hammer out. Fleming had convinced Curl to agree to pay as much as $5.8 billion in “incentive compensation,” which was considered an unusual arrangement, given that that was the amount Merrill had paid out a year earlier, before the market downturn. But both Curl and Fleming felt the sum was necessary to make certain they could retain the firm’s employees.

  It was growing late, and the Federal Reserve was still trying to get a reading of where the Bank of America–Merrill deal stood. The Federal Reserve Bank of Richmond, which had been overruled by Bernanke and Geithner earlier in the week about Bank of America’s capital ratios, was particularly concerned.

  At 9:49 p.m., Lisa A. White, assistant vice president at the Federal Reserve Bank of Richmond, concluded a conversation with Amy Brinkley, Bank of America’s chief risk officer. White immediately sent out an e-mail to her colleagues titled “BAC Update”:

  Just got off the phone with Amy Brinkley. She says that a deal with Merrill is solidified except for a few legal details that need to be worked out. Both boards have approved the deal, and once the legal issues are finalized, they will make an announcement….

  Amy indicated that BAC management feels a much higher level of comfort with Merrill than it did with Lehman, specifically with the value of the franchise and the marks on the assets. While Amy acknowledged that it may look to the outside world as if BAC is paying a bit of a premium for Merrill, BAC’s estimates of Merrill’s asset values indicate they are getting the firm at a 30–50% discount. Chris Flowers, the prominent private equity guru, has done extensive due diligence on Merrill over the past few months for potential equity investors, and I got the impression that BAC is at least partially relying on this work.

  Will pass along more details as we get them.

  After Chris Flowers left AIG, heading for a walk around Trinity Church at the intersection of Broadway and Wall Street, he decided to check in with Jamie Dimon, hoping to get some insight about the status of his bid for AIG, which he had left with Willumstad in the afternoon.

  “What are you hearing?” Flowers asked. “Willumstad hasn’t told us shit.”

  “You know, I think you pissed them off,” Dimon told him.

  “Okay. I don’t know why, but I guess we did,” he said, and hung up.

  As he walked back to 70 Pine Street, he took a moment to marvel at the huge takeover of Merrill on which he had just worked. With all the time he had been spending on AIG, it seemed almost like an afterthought. In the end, he hadn’t gotten a piece of the Merrill deal, but that hardly mattered. During the weekend’s insanity, his firm and Fox-Pitt Kelton, a boutique investment bank, had each been paid to write BofA a “fairness opinion.”

  A fairness opinion is usually touted as an independent, unconflicted seal of approval for a deal. But on Wall Street, they are often seen as little more than paid rubber stamps. In this case the situation was even more complicated, not only because Flowers himself had considered taking part in the Merrill deal, but because Flowers’s firm also owned Fox-Pitt Kelton.

  For their troubles, Flowers and Fox-Pitt would earn a combined $20 million in fees, $15 million of which was contingent on the conclusion of the deal. Not bad for less than a week’s work.

  Ruth Porat of Morgan Stanley had gone over to the apartment of a friend, a Lehman executive, to console her. Just as they were pouring a glass of wine to commiserate, she took a call from Dan Jester, her pal from Treasury, with whom she had just worked for over a month on Fannie and Freddie.

  “I need your help,” he told her. “You’re not going to believe this, but we think AIG may go into bankruptcy this week. I’m wondering if we can reconvene the team to focus on AIG.” In this case, the assignment would be to work on behalf of the Federal Reserve. He told her that he’d like Morgan Stanley to pull a team together and be down at the Fed in the morning.

  “Hold on, hold on,” Porat said in disbelief. “You’re calling me on a Sunday night saying that we just spent the entire weekend on Lehman and now we have this? How the fuck did we spend the past forty-eight hours on the wrong thing?”

  The drive home was excruciating; Fuld sat in the backseat feeling paralyzed. Gone was the bluster, the gusto, the fight. He was still angry, but really, he was just sad. For once, it was completely quiet except for the hum of the engine and the tires rolling down the highway. He had stopped looking at his BlackBerry.

  By the time his Mercedes rolled into his driveway, it was 2:00 a.m. His wife, Kathy, was waiting up for him in bed. He slowly walked into his bedroom, still in a state of shock. He hadn’t slept in days; his tie was undone and his shirt wrinkled. He sat down on the bed.

  “It’s over,” he said mournfully. “It’s really over.”

  Looking on solemnly, she said nothing as she watched his eyes well up. “The Fed turned against us.”

  “You did everything you could,” she assured him, rubbing his hand.

  “It’s over,” he repeated. “It’s really over.”

  CHAPTER SIXTEEN

  At 7:10 a.m. on Monday, September 15, Hank Paulson was sitting at the edge of his bed in a suite at the Waldorf Astoria, the day’s newspapers spread out before him. He had gotten very little sleep, worrying about how the markets would react to the previous day’s news—and about whether AIG would be the next domino to fall.

  The headline on the front page of the Wall Street Journal—spanning all six columns and running to two lines, in double the normal point size—told the story: CRISIS ON WALL STREET AS LEHMAN TOTTERS, MERRILL IS SOLD AND AIG SEEKS TO RAISE CASH. The Journal had gone to press before Lehman formally filed for bankruptcy protection at exactly 1:45 that morning in the Southern District of New York.

  Paulson was just finishing dressing when he received a call from President George W. Bush.

  Paulson had spoken to the president the night before but only briefly. This would be his first opportunity to explain fully whe
re things stood with the economy and to strategize with him about the administration’s message to the American people.

  His voice more hoarse than usual, Paulson began by telling Bush that Lehman’s bankruptcy filing was official. “I’m sure some in Congress are going to be happy about this, but I’m not sure they should be,” he added, acknowledging the political pressure that had been brought to bear against another bailout.

  Paulson said he was cautiously optimistic that investors would be able to accept the news but warned him that there could be further pressure on the financial system. Jim Awad, managing director of Zephyr Management, was quoted in that morning’s Wall Street Journal as saying, “Everybody’s prepared this time—it’s different from Bear Stearns. There could be a brief relief rally. You won’t get a 1,000-point shock drop because we’re all ready for it. But a grueling, long bear market will resume.”

  Although the U.S. markets wouldn’t open for another three and a half hours, Paulson told Bush that the Asian and European markets were down only slightly, and while the Dow Jones futures were off, it was only by approximately 3 percent.

  Paulson then recounted the specific details of the weekend, blaming the British government for misleading them. “We were out of options,” Paulson told Bush, who was sympathetic.

  But the president wasn’t concerned about what might have been. He told Paulson that he was unhappy about the bankruptcy, but that allowing Lehman Brothers to fail would send a strong signal to the market that his administration wasn’t in the business of bailing out Wall Street firms any longer.

  As they spoke, the first clues that the market wasn’t going to take the news especially well began appearing. Alan Ruskin, a banking analyst at RBS Greenwich Capital, had sent out a note to his clients early that morning trying to divine the meaning of Lehman’s bankruptcy:

  “At the time of writing it seems the US Treasury has decided to teach us ALL a lesson, that they will not backstop every deal in the wave of financial sector consolidation that is upon us,” he wrote. “Their motivation is part fiscal and part moral hazard. I suspect more the latter. Presumably the most important reason to teach Wall Street this lesson, is that they will change their behavior, and not take the decisions that are reliant on a public bail-out. For many, but not all, this is an impossible lesson to learn in the middle of the worst financial storm since the Great Depression.”

  Paulson walked Bush through the Fed’s plan to keep Lehman’s broker-dealer functioning so that it could complete its trades with other banks. “We’re hoping that over the next couple of days, they can unwind this thing in an organized way,” he said.

  While Paulson was clearly more disturbed than the president about Lehman’s bankruptcy, he expressed his elation about Bank of America’s decision to buy Merrill Lynch, a sign, he suggested, “of strength” in the market that might “mitigate” the possibility of panic.

  Paulson also warned him for the first time that “AIG could be a problem” but assured him that Geithner and the Fed were planning to rally the troops and help raise capital for the firm later that day.

  “Thanks for your hard work,” the president told him. “Let’s hope things settle down.”

  Doug Braunstein of JP Morgan was leaving his apartment on Manhattan’s Upper East Side at about 7:00 a.m. to head down to AIG when he received a call from Jamie Dimon.

  “New plan,” Dimon told him. “Geithner wants us to work with them to do a huge capital raise for AIG. There’s going to be a meeting down at the Fed at eleven a.m.” Braunstein, blocking his ear against the noise of Manhattan traffic, protested, “We can’t raise this kind of money.”

  Dimon promised that he’d have some help. “The government is inviting us and Goldman to make this happen.”

  A look of horror came over Braunstein’s face as he asked, raising his voice, “Where the hell did Goldman Sachs come from? Don’t they have a conflict? I mean, look at their exposure to AIG. They’re a huge counterparty.”

  Dimon dismissed his concerns. “The U.S. government is telling us to do this,” he repeated.

  Braunstein persisted. “But—”

  “Stop it,” Dimon insisted, annoyed that his top banker was challenging him. “This isn’t about us versus them,” he said. “We’ve been asked to help fix this situation.”

  Once Braunstein got to the office, he, Dimon, and Black huddled to come up with a game plan about how to handle the Fed’s unusual request. They decided to enlist the help of James B. Lee Jr., the firm’s vice chairman.

  Dimon hurried down the hall to give Jimmy Lee his marching orders. Lee, a classic suspender-wearing banker with a Golden Rolodex, had also arrived early to help manage the aftermath of Lehman’s collapse and had just gotten off the phone with one of his big clients, Rupert Murdoch. Sitting at a desk flanked by four computer screens, with a giant flat-screen television tuned to CNBC’s Squawk Box and his own private news ticker on the wall modeled after the Zipper in Times Square, Lee spun around in his chair.

  “I have a job for you,” Dimon barked, standing in the doorway. “I want you to go down to the Fed.”

  “To do what?” Lee asked in disbelief. After all, he had a busy day ahead of him, and he was expecting the market to be a disaster.

  “I want you to run the AIG deal,” Dimon told him. “Geithner called. He wants us to find a private-market solution for AIG. It’s a big hole. This could be the mother of all loans.”

  If there was one banker in the city who understood the world of debt and how to raise money in a pinch, it was Jimmy Lee. He was perhaps JP Morgan’s most senior dealmaker, a mogul unto himself with his own banquette at the Four Seasons at lunch. His power derived, in part, from the fact that he was a virtual ATM for corporate America, writing massive checks to finance some of the biggest deals in history. Dimon told him he was hoping that Lee could structure a deal to loan AIG enough money to keep operating and sign up a dozen other big financial players to follow him.

  With that tall order delivered, Dimon disappeared, and Steven Black followed him into Lee’s office to give him a five-minute briefing and a folder of AIG materials heavier than a phone book. Describing AIG as a “fucking nightmare client,” Black described how dire the situation was becoming. “You can carry the ball from here,” Black said with a wry smile, happy to have AIG in someone else’s lap.

  Lee was informed that he was expected at AIG for a meeting immediately and then he had to get over to the Federal Reserve Building by 11:00 a.m.

  Lee met Braunstein and Mark Feldman in front of JP Morgan’s headquarters on Park Avenue, where Lee’s driver, Dennis Sullivan, a retired police officer who had shuttled him from his home in Darien, Connecticut, to Manhattan every day for more than twenty years, was waiting with his black Range Rover. Braunstein and Lee jumped in the back so that Braunstein could continue briefing him.

  “C’mon. We’ve got to get downtown,” Lee instructed Sullivan. “No bullshit. We have to be down there like yesterday.”

  John Mack looked tired as he rose to a podium and began to address his top lieutenants. It had been a long weekend, he told the managers squeezed into Morgan Stanley’s main conference room. During two and a half days of meetings at the New York Fed, he said he subsisted on “nothing but wrap sandwiches” and fruit that had “been out a little too long.

  “I am energized and you ought to be energized, too,” Mack said encouragingly. He acknowledged that the market had come under tremendous pressure after Lehman’s “lost weekend”—United States stock index futures and bank shares in Europe were already tumbling—but the good news for them was that Morgan Stanley had survived.

  Mack proceeded to summarize the discussions about Lehman and Merrill that had taken place at the New York Fed over the weekend, calling Lehman’s demise “very unfortunate.

  “I mean, I wish I could come in here and say, you know, this is a great opportunity, kick back, we’re going to do great, all of the competitors have basically been eliminated. I’m not
going to say that,” he allowed. “What I want to say is: Kick it up. Work harder. Think about what has happened this year. And what has happened is that all of a sudden, three of our competitors are no longer in business.”

  Mack added: “I understand that all of you, and not just all of you here, but I think in the industry, are shaken. You should be shaken. But that doesn’t mean that we crawl back in and we shake….

  “We’re here to do business, to serve our clients, to take market share. Just think about this: Every 1 percent in equity market share we gain is a billion dollars in revenues….

  “I think that once this turmoil abates, and it will settle down, the opportunities going forward are unbelievable. Now I am a positive guy but I am not a Pollyanna, and I believe with all my heart that this firm and our competitor, Goldman, have unique opportunities now. And I am sorry that we got to these unique opportunities the way we did. I don’t want my competitors out of business, I just want to beat them.”

  His chief financial officer, Colm Kelleher, chimed in to punctuate that point: “There is Darwinism here…. Weak people are being taken out. Strong people, I believe, are going to do very, very well.”

  Over at Lehman Brothers, the thirty-second floor conference center was a beehive of activity, with hundreds of dazed people streaming in and out—bankruptcy lawyers, restructuring experts, outside consultants. Fuld, who had been escorted upstairs by Lehman’s security detail for fear that employees might actually attack him, wandered in and out of the conference rooms in shock. He had already placed a call that morning to Geithner, pleading with him to undo the bankruptcy filing, as if it had all been just a bad dream.