Too Big to Fail

by Andrew Ross Sorkin

  The occasion was the approval of the sale of Lehman Brothers to Barclays by a bankruptcy judge. While the rest of the world had already moved on to the fates of Morgan Stanley and Goldman Sachs, ten thousand Lehman employees’ jobs still lay in the balance. More than 150 lawyers, including some of the most prominent bankruptcy practitioners in the nation, were present on behalf of various creditors. Chelsea Clinton was in attendance, representing the hedge fund Avenue Capital.

  The proceedings had begun at 4:36 p.m., and Judge James Peck had insisted that he would reach a verdict before leaving for the night. The urgency of getting the sale approved was growing more and more evident as with each passing hour the markets chipped away at the value of Lehman’s assets. Not only was the bankruptcy of Lehman, which had filed for Chapter 11 with $639 billion in assets, by far the largest in the nation’s history, but an unwinding of so complex a financial institution had never before been attempted.

  On this late summer evening, the courtroom was on the warm side—the windows were closed and, for lack of enough chairs, people had taken to sitting on the air vents. Lawyers from the firm representing Lehman, Weil, Gotshal, carried in ice water.

  Signaling to Harvey Miller of Weil Gotshal, Judge Peck said: “You may approach, if that’s what you’re doing. I can’t really tell. Frankly, with so many people in the courtroom, whenever I see the movement this way, I get a little concerned. Mr. Miller?”

  Miller, even under these circumstances dapper in a gray suit, red tie, and blue shirt, outlined the deal: Barclays would pay $1.75 billion for Lehman’s North American operations. “This is a tragedy, Your Honor,” Miller said of what had happened to Lehman Brothers. “And maybe we missed the RTC by a week,” he added, referencing the development of the new TARP program. “That’s the real tragedy, Your Honor.”

  “That occurred to me as well,” Judge Peck said sympathetically.

  Many of the lawyers for Lehman’s creditors, however, were less charitable. They were furious about Lehman’s deal with Barclays, suggesting it was paying far too little and complaining about ambiguities in the purchase agreement. Daniel H. Golden of Akin Gump Strauss Hauer & Feld, representing an ad hoc group of investors holding more than $9 billion of Lehman bonds, pleaded with the court for a brief delay.

  “There has simply been no credible evidence adduced at this hearing that the price that Barclays is paying for these assets represents fair value,” he said. “There’s no other testimony or evidence that suggests the other assets being purchased by Barclays represent fair value or an attempt to maximize value for creditors.”

  Miller, taking umbrage at the mere suggestion that the deal wasn’t fair, shot back that the transaction had to be approved by the court immediately.

  “I don’t want to use the melting ice cube” analogy, he said, the emotion showing on his face. But “it’s already half melted, Your Honor…. The things that have happened since Wednesday, make it imperative that this sale be approved. In the interest of all of the stakeholders, including Mr. Golden’s clients, they will benefit by this, Your Honor, because if the alternative happens, there will be very little to distribute to creditors, if anything.”

  Nearly eight hours and three recesses into the hearing, after arguments by dozens of lawyers, several interruptions because of static from the speakers, and one brief aside about Judge Wapner’s The People’s Court, Judge Peck, moved by the enormity of trying to save what was left of a more than century-old firm, agreed to sign off on the Barclays deal.

  “This is not simply approving the transaction because Mr. Miller is putting pressure on me to do so,” the judge explained. “This is not approving the transaction because I know it’s the best available transaction. I have to approve this transaction because it’s the only available transaction.”

  With a heavy heart, he went on to offer a eulogy: “Lehman Brothers became a victim. In effect, the only true icon to fall in the tsunami that has befallen the credit markets. And it saddens me. I feel that I have a responsibility to all the creditors, to all of the employees, to all of the customers and to all of you.”

  It was 12:41 a.m. when Judge Peck ended the hearing. As he stepped down from the bench, the courtroom, with at least several people moved to tears, erupted in a wave of applause.

  Tim Geithner hadn’t slept well on Friday night, having decided to stay in one of the grim rooms on the twelfth floor of the Federal Reserve. By 6:00 a.m., he had returned back upstairs to his office dressed in an oxford dress shirt and sweat pants, and began puttering around the hallways in his stocking feet.

  In his mind, he was already making battle plans. He had made it safely to the weekend, but he already was worried about what would happen on Monday if he didn’t find a way to save Morgan Stanley and Goldman Sachs.

  “John’s holding on to a slim reed,” Paulson had told Geithner about John Mack’s perilous position on a phone call the night before. They had heard that Morgan Stanley had only about $30 billion to $40 billion left, but Paulson was also still anxious about Goldman Sachs, his former employer. “We’ve got to find a lifeline for these guys,” said Paulson, and they reviewed the possible options.

  On a pad that morning, Geithner started writing out various merger permutations: Morgan Stanley and Citigroup. Morgan Stanley and JP Morgan Chase. Morgan Stanley and Mitsubishi. Morgan Stanley and CIC. Morgan Stanley and Outside Investor. Goldman Sachs and Citigroup. Goldman Sachs and Wachovia. Goldman Sachs and Outside Investor. Fortress Goldman. Fortress Morgan Stanley.

  It was the ultimate Wall Street chessboard.

  Lloyd Blankfein arrived at his office at just past 7:00 on Saturday morning. Even though he was still pushing his “Fortress Goldman” bank holding plan, he and Gary Cohn had assigned more than a half dozen teams to start investigating different deals: HSBC, USB, Wells Fargo, Wachovia, Citigroup, Sumitomo, and Industrial and Commercial Bank of China.

  Cohn had had another conversation with Kevin Warsh of the Federal Reserve on Friday, who encouraged him to keep looking at merger options, especially at Citigroup. While it had never been made public, Goldman had explored the idea of merging with Citigroup several times over the past eighteen months but had never engaged in formal talks. Cohn and Warsh had discussed the possibility at least twice before, and even though Cohn always resisted the idea, he was intrigued.

  Initially Cohn’s notion was that Citi should buy Goldman; he had even established an asking price. But Warsh suggested that Cohn approach it the other way around: Goldman should be the buyer. To Cohn that made no sense given that Citi was so much bigger. But what Warsh knew—and hadn’t yet shared with Cohn—was that Citigroup’s balance sheet had so many holes that its value was likely a lot lower than its current stock price.

  As a result, the Fed was considering three possible outcomes for Citi, code-named “NewCo,” “Goldman Survivors,” and “Citi Survivors.”

  Blankfein was reading an e-mail when John Rogers, the firm’s chief of staff, arrived. Blankfein pressed a secret button under his desk to open remotely the glass door to his office. (Paulson had installed the Inspector Gadget–like device when he was Goldman’s CEO.)

  As he and Rogers were reviewing their own battle plans, Geithner called. In his usual impatient tone, he insisted that Blankfein immediately call Vikram Pandit, Citigroup’s CEO, and begin merger discussions. Blankfein, slightly shocked at the directness of the request, agreed to place the call.

  “Well, I guess you know why I’m calling,” Blankfein said when he reached Pandit a few minutes later.

  “No, I don’t,” Pandit replied, with genuine puzzlement.

  There was an awkward pause on the phone. Blankfein had assumed that the Fed had prearranged the call. “Well, I’m calling you because at least some people in the world might be thinking that combining our firms would be a good idea,” he said.

  After another few moments of uncomfortable silence Pandit finally replied, “I want you to know I’m flattered by this call.”


  Blankfein now began to wonder if Pandit was putting him on. “Well, Vikram,” he said briskly, “I’m not calling with any flattery towards you in mind.”

  Pandit hurriedly ended the call: “I’ll have to talk to my board. I’ll call you back.”

  Blankfein hung up and looked up at Rogers. “Well, that was embarrassing. He had no idea what I was talking about!” From Blankfein’s perspective, he had done what he was asked to do, only to be shown up.

  Blankfein phoned Geithner back immediately. “I just called Vikram,” he said testily. “As I think about it, you never told me whether Vikram was expecting a call, but I inferred it. He behaved as if he wasn’t expecting the call and he convinced me that he wasn’t expecting the call.”

  Geithner had miscalculated—could Pandit not see the gift that was being handed to him? It defied all reason. But Geithner had no time to deal with anybody’s injured feelings. “Okay, I’ll talk to you later,” he said before hanging up. Blankfein sat there, wondering what the hell had just happened.

  Alan Greenspan and his wife, Andrea Mitchell, the NBC News journalist, were mingling in the crowd outside the grand ballroom at the St. Regis Aspen Resort on Saturday morning, the second day of Teddy Forstmann’s weekend conference. They were all waiting for the next panel to begin, entitled “Crisis on Wall Street: What’s Next?” By Wall Street standards it was a star-studded event: The panelists included Larry Summers, the former Treasury secretary; Mohamed El-Erian, CEO of PIMCO, whose book When Markets Collide had just been published; CNBC’s conservative talk-show host Larry Kudlow; and perhaps the most intriguing, Bob Steel of Wachovia. Steel, who had considered canceling, had flown into Aspen that morning, leaving his home at 4:00 a.m. to arrive on time.

  By the time the moderator, Charlie Rose, got to the Q&A portion of the panel, however, Steel was nervously checking his watch. Greenspan had entered a debate about the controversies of mark-to-market accounting, but Steel knew he had to get back to the East Coast immediately. The moment the panel ended, he tried to bolt out of the room but on the way out encountered Richard Kovacevich, the CEO of Wells Fargo, someone he thought could be a merger partner.

  “I was going to call you next week,” Steel told him.

  “Yes, I wanted to catch up,” Kovacevich replied.

  “I’m running back to the airport. I’ll call you,” Steel promised.

  Jumping into his black Jeep Wrangler on the way to the airport, he finally had a minute to check his BlackBerry and discovered that Kevin Warsh had sent him several e-mails urging him to contact him immediately.

  “Listen, I have a call for you to make,” Warsh told Steel when he finally reached him. “We think you should connect with Lloyd!”

  Steel, reading between the lines, was stunned: The government was trying to orchestrate a merger between Goldman Sachs and Wachovia! On its face, he knew that it could be a politically explosive deal, considering the two firms’ connections to Treasury. Paulson, he imagined, must be involved somehow. But, of course, Paulson wasn’t allowed to contact him directly. Steel was immediately anxious about the idea. If Goldman had really wanted to buy Wachovia, he thought, it would have done so long ago. After all, up until this week when he spoke to Mack, Goldman had been on Wachovia’s payroll as its adviser, and as such, knew every aspect of its internal numbers. So, if there was a bargain to be had, then Goldman hadn’t seen it. Still, Steel saw the merits in such a deal, and if it was being encouraged by the Federal Reserve, he imagined it might just happen.

  “I spoke to Kevin, and he said to give you a call,” Steel began when he got through to Blankfein.

  This call, unlike the Citibank fiasco, had been prewired. “Yes, I know,” Blankfein said. “We’d be interested in putting a deal together.”

  Steel told Blankfein he was about to step onto Wachovia’s corporate jet and could be in New York by late that afternoon.

  As his plane headed for the East Coast, Steel mused how a deal with Goldman would be something of a homecoming, even if it had come as a direct order from the government. Perhaps he could even wangle the chairman title.

  Jamie Dimon had been hoping to be able to take his first day off in two weeks. That was until Geithner called him early Saturday morning and instructed him—the president of the New York Federal Reserve seldom suggested anything—to start thinking about whether he’d like to buy Morgan Stanley.

  “You’ve got to be kidding me,” Dimon replied.

  No, Geithner said, he was quite serious.

  “I did Bear,” Dimon objected, referring to buying Bear Stearns. “I can’t do this.”

  Geithner ignored his answer. “You’ll be getting a call from John Mack,” he said and hung up the phone.

  Mack, who had had a similar peremptory call from Geithner, phoned Dimon five minutes later. Dimon reiterated that he didn’t want to buy Morgan Stanley, which he had already told Mack earlier in the week. But Dimon was under orders to try to help Mack, so the two rivals talked about whether JP Morgan could offer Morgan Stanley a credit line that might give it some breathing room. Dimon said he’d think about it and get back to him with a decision.

  As soon as he got off the phone with Mack, Dimon called Geithner. “I talked to John,” he said. “We’re talking about getting him a credit line.”

  “I don’t know if that’ll be enough,” Geithner said, frustrated at the news. His order had not been explicit, but he hinted heavily that the Federal Reserve very much wanted the two firms to form a union and wasn’t the slightest bit interested in any temporary measures.

  Dimon immediately sent an e-mail to his operating committee, summoning them to the office, and within an hour, dressed in golf shirts and khakis, they had assembled in a conference room on the forty-eighth floor.

  Dimon had a grimace on his face as he related the call he’d received from Geithner. Merging the “Houses of Morgan” was not a new idea but hadn’t come up in any serious fashion since June 20, 1973, when Morgan Stanley, JP Morgan, Morgan Guaranty, and the British Morgan Grenfell held a top secret meeting in Bermuda, code-named “Triangle,” at the Grotto Bay Hotel.

  On a whiteboard Dimon used a black marker to sketch out what he had been thinking. “We can either buy them, buy part of them, or give them some type of financing.”

  For the next two hours they went around in circles, considering their options. What parts of Morgan Stanley could be spun off? What parts could be warehoused (the term for buying a property, keeping it relatively intact if not in fact making it healthier, and then selling it later, when the market recovered)? Maybe they could buy Morgan Stanley, Dimon suggested aloud, and then create a new tracking stock for it?

  But all these scenarios wound up circling back to the same problem: What, exactly, would they be buying? The overlap between the firms was enormous. And what were Morgan Stanley’s toxic assets really worth? These were all but unanswerable questions at that time.

  John Hogan, JP Morgan’s chief risk officer, who had attended the meeting with Lehman Brothers the previous week, stepped out of the operating committee conference room and called Colm Kelleher and Ken deRegt at Morgan Stanley.

  “I don’t know exactly what you guys have in mind, but under any scenario where we ‘help you,’ we’re going to need a bunch of information,” he said. “Could you go back and talk to Mack and find out exactly what it is that you’re expecting, that you’d like from us in terms of this ‘help’?” There was more than a little condescension in Hogan’s voice, and Kelleher and deRegt picked up on it immediately.

  A half hour later Kelleher got back to Hogan with an outline for a request for a $50 billion line of credit. Kelleher was hoping that if JP Morgan did come through with an offer, Dimon would not be as punitive as CIC had been.

  Hogan sent an e-mail to JP Morgan’s senior team with the subject line “URGENT and Confidential.” In it he spelled out the plan:

  Pls plan to meet at Morgan Stanley’s offices at 750 7th Ave tomorrow at 9:30am. We don’t have the floo
r or room as yet—MS contact person is David Wong. The purpose of the meeting is for us to consider entering into a secured financing against a variety of different unencumbered assets at MS.

  Geithner was by now seriously miffed. He had been trying to reach Pandit since eight in the morning and had just heard back from Blankfein, who had somehow actually managed to get through to Pandit again. The only problem was that Pandit had turned Goldman down, and Geithner hadn’t even had a chance to speak with him.

  Finally, he got through to him.

  “I haven’t been able to reach you for four hours,” Geithner barked into the phone. “That’s unacceptable on a day like today!”

  Apologizing, Pandit explained that he had been talking to his team about the Goldman proposal, which they had ultimately rejected. “We’re concerned about taking on Goldman,” Pandit said, trying to explain his rationale for turning them down. “I don’t need another trillion dollars on my balance sheet.”

  Geithner could only laugh to himself. “This is a bank,” Pandit said. “And a bank takes deposits and a bank has a prudency culture. I cannot envision a bank taking its deposits and investing them all in hedge funds. I know that’s not what Goldman is, but the perception is that they’d be taking deposits and putting them to work against a proprietary trade. That can’t be right philosophically!”

  Having dispensed with pushing Goldman and Citigroup together, Geithner moved on to his next idea: merging Morgan Stanley and Citigroup.

  Pandit had been considering that option, too, and while he was more predisposed to merging with Morgan Stanley, he still was reluctant. “It’s still not our choice to do this deal, but we could think about it,” he told Geithner.

  By 2:00 p.m., John Mack was growing concerned that the talks with CIC were going nowhere. Gao hadn’t budged on what Mack was calling an “offensive” offer. He had no idea what Jamie Dimon would come up with, and he hadn’t heard anything from Mitsubishi.