by Matt Taibbi
One executive, Michael Gelband, a managing director and head of global fixed income, stood on the table and begged Fuld to reconsider. As far back as 2005, Gelband had given a presentation warning of the dangers of subprime and had been mostly ignored. By late 2006, at exactly the moment Viniar was persuading Goldman to reverse course, Gelband pleaded with Fuld to do the same. “The world is changing. We have to rethink our business model,” he told Fuld.
Fuld blew him off. “You’re too conservative,” he said.
Soon afterward, at a March 2007 meeting, the board decided that the seeming collapse of subprime was not a problem but rather an opportunity to jump back in, and jump in huge. “The current distressed environment,” concluded the board, “provides substantial opportunities.”
Eventually, Fuld would be persuaded to dial back on the subprime strategy, but by then it was far too late, and the rollback strategies he employed were far too meager. More important, the bank by then had begun its descent into a muck of crooked borrowing schemes, all designed to whitewash the firm’s already catastrophic financial condition.
Hiding the truth became harder when the famed Bear Stearns investment bank went bust in March 2008. After Bear’s collapse, due to a fatally overenthusiastic miscalculation about subprime, regulators scanned the landscape and wondered what other Wall Street investment banking titans might be hiding toxic inventories from the markets. Their eyes settled on Lehman, and teams of investigators from the New York Fed (run at the time by an ambitious bureaucrat named Timothy Geithner) and the SEC set up shop at Lehman to monitor the company’s cash-flow situation, ostensibly to prevent another Bear from happening.
But Lehman kept protesting that it was in fine shape, and regulators somehow kept buying its explanation. In truth, the bank was already near the end of a long slide into a habit of desperately borrowing just to keep its doors open. It had started with borrowing cash in three-month loans, then it was one-month notes, and then the cycle got even tighter and crazier. By the end of 2007, Lehman was sometimes borrowing $100 billion or even $200 billion a day or more just to stay afloat. The life-saving cash injections came from overnight “repo” loans from banks like Fidelity that Lehman took out at the end of every single business day. And the first thing in the morning, it was paying off those loans by taking out matching amounts of “intraday” loans from banks like JPMorgan Chase. Then it was rinse, repeat: continue the cycle by rolling the loans later that night.
Chase’s was a junkie’s banking strategy, shooting speed in the morning and spending all day foraging for the cash to dope down at night, an endless quest to chase the debt dragon.
One banker who was part of a team that later conducted a forensic examination of the Lehman bankruptcy talked about this insane financing strategy. He recounts talking to a Lehman employee who was responsible for arranging the overnight loans. “Between six in the morning when you get in or seven in the morning, you’re contacting trading desks, and by the end of the day, you have to find lenders for $200 billion,” he said. “I mean, it’s crazy.… I didn’t know that’s how these people functioned. Nobody did.”
How do you get someone to lend you $200 billion overnight? The simplified answer is that you pledge collateral for cash. Lehman would go to a company like Chase or Fidelity carrying armfuls of corporate loans and commercial mortgages and whatever else it had in the cupboard, and dump them on that bank’s doorstep, asking for billions of cash in return. Normally it could simply roll the same loans over and over again, but as its cash needs grew, it began to get more and more desperate, pushing ethical boundaries left and right.
First it lied about the quality of its collateral, and then it came to the ultimate counterfeit collateral scheme. In the wake of the collapse of Bear Stearns, Lehman’s leaders decided to try a sort of financial publicity stunt called a “liquidity pool”: they would show the world they weren’t as broke as Bear Stearns by announcing the existence of a giant pile of liquid assets that they could call on in an emergency to pay their bills.
In June 2008 their CFO, Ian Lowitt, announced in a conference call that Lehman had a big stack of $45 billion in assets, a reserve fund that was “never stronger.”
But most of what made up that $45 billion liquidity pool would turn out to be stuff that Lehman had already hocked once or twice to other banks and institutions in exchange for cash. Chase, for instance, accepted a $5 billion chunk of collateral that had been pledged to this liquidity pool. In another case, Lehman pledged nearly $3 billion of notes that its own employees derided as “goat poo” as collateral to Chase and to the liquidity pool, making the deal a triple-whammy: it overrated the notes and then pledged the overrated notes for collateral to two different places at once. (The deal, known as the Fenway or Hudson Castle deal, was actually a regulatory quadruple-whammy, as it also involved a complex Enronesque self-dealing scheme of questionable legality.)
Investigators later concluded that of the $30 billion in assets that was supposed to be in the pool in the bank’s last days, perhaps only $1 billion or $2 billion was actually available to the bank. The rest had long ago been put up for cash to help the bank pay for its subprime addiction.
The bank had taken an even more decisive step in the direction of fraud when it invented a devious and desperate accounting trick called Repo 105 to Botox its balance sheet.
To simplify: Lehman was borrowing huge sums of money at the end of every quarter—as much as $50 billion—and booking those loans as sales. This is a little like taking out a cash advance on your credit card and telling your wife you earned the money pulling extra overtime shifts selling Amway products door to door.
Things got so bad that in mid-June 2008 the ranks finally mutinied. Fifteen of the company’s managing directors stood up to Fuld and demanded radical changes. It was roughly this same group of senior employees who would later resurface in another mutiny, during the firm’s collapse. But for now the group tried to save the firm by urging Fuld to change course.
Outflanked, Fuld had no choice but to comply. He fired Gregory and began moving from department to department, asking traders to chop down the bloated balance sheet, get rid of a billion in risk here, a billion in risk there.
But it wasn’t enough. Lehman was in debt significantly beyond its eyeballs. It was still borrowing huge amounts every day and was exquisitely vulnerable to the slightest change in public perception about its soundness.
As investigator Anton Valukas later explained in his report on the firm’s bankruptcy, even the slightest slowing in sales of things like subprime collateralized debt obligations (CDOs) would make Lehman’s lenders nervous about the hundreds of billions in cash loans they were forking over every day—and the instant those lenders lost confidence, the end would come, exploding-death-star style.
“Confidence was critical,” Valukas wrote. “The moment that repo counterparties were to lose confidence in Lehman and decline to roll over its daily funding, Lehman would be unable to fund itself and continue to operate.”
Crucially, authorities by then had already been contacted about illegalities and improprieties within the bank. One of its lawyers, Oliver Budde, had gone to the SEC in April 2008 with evidence that a number of Lehman executives, including Fuld, had been systematically underreporting their income to the IRS through their misuse of a kind of stock award called restricted stock units. Fuld’s misstatements alone represented hundreds of millions of dollars in underreported income.
But the SEC blew Budde off. “If we had a properly functioning SEC and regulatory structure,” he says, “my information would have raised gigantic red flags at the SEC, who then should/would have notified all the related regulators.… It should have had monumental impact.”
Meanwhile, another whistle-blower, a senior accountant named Matthew Lee, had alerted not only senior executives at Lehman but Lehman’s auditor, Ernst & Young, to serious improprieties at the firm. Among other things, Lee told Ernst & Young all about the Repo 105 scheme in June
2008, months before the firm collapsed.
None of this, however, came out in time to prevent investors from buying stock in Lehman in the months before its collapse.
How many people would have invested in Lehman if such information had been known? But it wasn’t, making it a classic disclosure offense. One former high-ranking SEC official said he was shocked that no enforcement action was ever brought. Valukas, too, identified numerous areas where “colorable” claims could be made, like Repo 105 and the liquidity pool.
Budde insists that all sorts of charges could have been filed against Lehman executives. “I say bust them,” he says, citing Repo 105, the stock award problems he uncovered, and the Hudson Castle deal, which, he says, “is Enron-type bullshit. If it was punishable then, why not now? No relevant laws were changed in the meantime.”
But nobody was ever charged, a fact that is all the more incredible when one considers that the bank practically had regulators living in its backside from the moment Bear Stearns collapsed through the end.
One incredible moment in the precollapse history of Lehman underscores the two-faced approach the government took toward policing this bank. Among the banks that Lehman was borrowing its massive amounts of cash from in its last years was JPMorgan Chase. In the kinds of repo loans Lehman was taking out, the borrower is usually forced to post a slightly larger amount of collateral than it gets back in cash. If you want $100 billion in cash, for instance, you normally have to post $105 billion in collateral. That extra 5 percent, called a haircut, is standard in almost every loan of this type.
But Chase was not asking for a haircut from Lehman prior to 2008. It was engaged in “100 percent collateral intraday lending,” which just means it was giving out massive bundles of cash in exchange for exactly equivalent amounts of collateral. Insiders and investigators who later examined these deals now say that Chase had simply been lazy. “They weren’t paying attention” is how one source puts it.
This was so irresponsible that in January 2008, the Federal Reserve—doing its job as the primary banking regulator—went to Chase, tapped the firm’s leaders on the shoulder, and suggested that they start paying more attention to their relationship with Lehman. “They were like, ‘You guys have to manage your risk better,’ ” one investigator said.
Chase followed the Fed’s advice and in early 2008 went back to Lehman and asked the bank for more collateral. Lehman, incredibly, told Chase it couldn’t afford it—at least not yet. It begged Chase to allow it to start paying more collateral by degrees, 1 percent at a time, until it could get to the point where it was paying that 5 percent haircut.
What’s amazing about this is that the Fed saw fit as early as January 2008 to warn Chase about Lehman’s instability. But nobody ever warned the public. Nobody stepped in after the bank cooked its books in Repo 105, or misreported taxes, or made fake disclosures, or lied outright to investors. Nothing was done. The government merely sat back and watched the catastrophe unfold, allowing new victims to pour money into the walking-dead bank right up until its collapse.
THE SHIP BEGINS TO SINK
By the end of the summer of 2008, Fuld realized that the bank could not continue to stay afloat on its own. He needed a savior, someone to whom he could sell, and sell quickly, his rapidly disintegrating empire of “goat poo.”
Fuld would sell to anyone, public or private, it made no difference. A federal rescue was possible. Bear Stearns had gotten one—Geithner and the Fed had helped JPMorgan Chase buy the company. But when Lehman posted a $2.8 billion loss in the second quarter, Treasury Secretary Hank Paulson, a former head of Goldman Sachs, Lehman’s bitter historical rival, had told Fuld that if he didn’t find a buyer, Lehman would go the way of the mammoths. One more losing quarter, he implied, and Lehman would be kaput.
Freaked out, Fuld tried to save Lehman in August 2008 by selling the firm to the Korea Development Bank. On August 22 the firm seemed poised to survive on the strength of that merger, as shares in the firm actually rose 5 percent that day on the rumors. But the state-owned Korean bank soon backed out, and on September 9, Lehman shares plummeted 45 percent to $7.79 a share. The next day the company announced a $3.9 billion third-quarter loss. The markets panicked and began unloading Lehman stock like it was tainted with plague.
It was Wednesday, September 10. A week before, Sarah Palin had reenergized the Republican Party with a dazzling speech on the floor of the Republican National Convention in St. Paul, Minnesota. The troubles of Wall Street barely rated a blip at that convention, but the truth was that the first big domino in the 2008 crash was about to fall. Lehman Brothers was dying. Without a buyer, it would be dead within a week, or sooner.
Fuld himself was already toast, but he didn’t know it yet. By the time the seventh anniversary of September 11 arrived, a Thursday, the once-feared Gorilla’s desperation to throw himself into the arms of Bank of America, Barclays, the taxpayer, or really anyone who would even consider saving his firm had reached levels of both the darkest tragedy and the blackest comedy.
He tried Morgan Stanley’s John Mack on Thursday, September 11, only to be told by Mack that there was “too much overlap” between the firms.
Next he tried Bank of America’s Ken Lewis, who he was convinced would be there for him in a pinch. He called Lewis repeatedly throughout the next day, Friday the twelfth.
Strangely, however, Lewis didn’t call him back, not even once. Fuld, characteristically, saw no significance in this fact. Probably, he thought, Lewis wasn’t checking his messages. No way he wouldn’t answer the calls of Dick Fuld!
Humorously, Fuld would keep calling Lewis for days, until finally—and this isn’t a joke—Lewis got his wife to answer his phone for him.
Moments like this are the backstory to the 2008 crisis: Ken Lewis’s wife had to break the news to Dick Fuld that Bank of America would not be rescuing Lehman Brothers.
In fact, Lewis decided he wasn’t going to buy Lehman Brothers unless the government got the taxpayer to buy all its toxic stuff, leaving only the edible, profitable parts for Bank of America. This was something that the federal government had already done in the Bear Stearns deal, and would do again in the Wachovia and Washington Mutual deals, and would even do that very week for Lewis himself in the Merrill Lynch deal.
But it wouldn’t do it for Lehman Brothers. Hank Paulson was Rick Blaine in Casablanca, not willing to sell the transit papers to Victor Laszlo, not for any amount of money—there was apparently no price he would consider to save Dick Fuld.
Unable to sell himself to any bank in America or Asia, Fuld now called Bob Diamond, the CEO of the British giant Barclays, and asked if they could meet. This set in motion a chain of events that would lead to Lehman’s last crooked trade.
Diamond agreed to meet Fuld. On that Friday, September 12, the Barclays chief made a stealth visit to the Lehman offices downtown, coming in through the service entrance (“The garage, I guess, the back way,” he would testify later) and then taking a long serviceelevator ride with Fuld, just the two of them, up to Fuld’s thirty-first-floor offices.
In that ride up the service elevator, Diamond ripped out what was left of what passed for Fuld’s heart.
A lipless, pale-faced Irish Catholic from Concord, Massachusetts, who wears Coke-bottle glasses and appears in public wearing the pinched, joyless manner of a constipated nun, Diamond, who came up through the banking ranks at Morgan Stanley and First Boston, was one of the great ambassadors of American financial culture. Among other things, he helped export the cherished practice of unnecessarily massive executive salaries to the English business world, once even attracting criticism from British officials for his lack of “humility” and “modesty” when it was reported that he had paid himself the hilarious sum of £63 million in a single year.
Diamond was himself only four years away from being washed down the drain of history in his own lurid corruption scandal—more on that later. But on that Friday, September 12, he would find himself in the f
antastically satisfying position of being able to push one of the great assholes of our times, Dick Fuld, to the brink of unemployment and total humiliation. In the elevator, Diamond cavalierly told Fuld that he wasn’t interested in buying Lehman Brothers unless Fuld was willing to sell the firm basically for free. “It would have to be a rescue situation,” he told him coldly. “Meaning if this is a very, very distressed price.”
Diamond’s elevator dissing left Fuld devastated. Of course, upon hearing that Barclays would buy Lehman only if Fuld gave it away, Fuld—again, according to court testimony—promptly did the predictable thing. He turned around and told the Lehman board that the deal was very much alive, that Barclays had only just started its due diligence process, that it had nothing to worry about. It was now late Friday evening, and Lehman’s share price had closed at $3.65. The firm was in its final death throes.
Meanwhile, as the weekend of September 13–14, 2008, began, a series of meetings kicked off across town, at the offices of the New York Fed, that would dramatically reshape not just the American economy but the economy of the entire world. Hundreds of bankers and lawyers from most every bank and major Wall Street law firm in the city gathered at the regal, marble-floored building to hammer out a rescue of the insurance giant AIG, which like Lehman was also spiraling toward collapse and ruin.
The rescue of AIG that those men and women cooked up, in which the government assumed AIG’s debts in full, had the consequence of saving AIG customers like Goldman and Deutsche Bank from billions of dollars that they would otherwise have lost. Moreover, the Fed and the U.S. Treasury, in the persons of Timothy Geithner and Hank Paulson, would shortly thereafter allow both Goldman and Morgan Stanley to convert themselves into commercial bank holding companies, thereby gaining access to billions of dollars of emergency financing from the Federal Reserve.
The deals the government and Wall Street worked out that weekend to save the likes of AIG, Goldman, Deutsche Bank, Morgan Stanley, and Merrill Lynch were unprecedented in their reach and political consequence, transforming America into a permanent oligarchical bailout state. This was, essentially, a formal merger of Wall Street and the U.S. government.
