The Divide: American Injustice in the Age of the Wealth Gap
Page 18
Only one actor was left out of the party: Lehman Brothers. When Fuld proposed that the government let Lehman make the same move to become a commercial bank, giving it the same life-giving access to the Fed’s billions, Paulson told him to stuff it.
By Sunday morning, Fuld was ready to do Diamond’s humiliating “sell yourself for free” deal. But when he tried to crawl from his knees into Diamond’s lap, he found out even that deal was now impossible. It turned out that an obscure British regulatory provision prevented Barclays from taking over Lehman’s trading obligations without a shareholder vote, nixing any immediate mano-a-mano Barclays deal. When the British financial regulator, the Financial Services Authority (FSA), refused that weekend to provide a waiver for that requirement, the original Barclays fire-sale buyout proposal—which came to be known as “Barclays One”—was basically dead.
Beyond desperate now, Fuld called Paulson that Sunday and begged him to call British prime minister Gordon Brown to intervene. Paulson said he was busy. Fuld then begged Paulson to ask George Bush to call Brown. Same thing—no dice. Fuld even thought about reaching out to Jeb Bush to induce George to call Gordon Brown, but that idea, too, somehow collapsed.
Wearily, Fuld then ended where he’d begun, trying to sell himself to John Mack at Morgan Stanley one last time. Mack told Fuld he had enough problems of his own.
By the next morning, Fuld was out, stepping down when the last hope of avoiding bankruptcy vanished. A new group, led by the aforementioned “best risk taker,” Bart McDade—a Lehman official with a reputation for integrity, a man who had once publicly questioned Fuld’s subprime strategy—and a few dozen executives loyal to him, stepped in to take over. This new group faced the same devastating financial reality that Fuld had, but they had one thing going for them: the absence of Fuld. Without having to worry about propping up Lehman long enough to save Fuld’s reputation, they were free to make one final, brilliantly ice-cold deal to save themselves. What would they do?
THE MUTINY
Sunday night, September 14, 2008. The world was changing. AIG was being nationalized. Goldman and Morgan were on their way to their own cushy rescues. Merrill Lynch was being shotgun-wedded to Bank of America. Wachovia was on its way to being swallowed up by Wells Fargo. All those companies were being saved, but Lehman was left without enough money to open for business the next morning. If it didn’t declare bankruptcy by morning, the bank would implode, and its leveraged-to-the-hilt, $700 billion nuke-bomb of a balance sheet would detonate, perhaps igniting a global chain reaction of losses.
That last Sunday evening, some of the remaining executives and board members were still unconvinced that the government would actually risk such a scenario by letting Lehman fail. According to testimony, in fact, Henry Kaufman, one of Lehman’s directors, argued that Sunday for “calling the government’s bluff,” and just going ahead and opening for business the next morning, essentially daring the government not to bail Lehman out.
But the Fed and the SEC kept calling the Lehman board that Sunday and assuring the company: We’re not joking, you clowns. There’s no bailout. Declare bankruptcy now—it’s your only option.
When the grim reality that no bailout was coming finally sank in, the company shifted gears. With Fuld gone and the fiction of a last-minute, company-saving deal finally gone with him, these seasoned veterans of high-risk, daredevil finance decided to make one last inspired trade. They decided to rob their own bank.
“Traders have no loyalty to anybody,” one former high-ranking Lehman executive explained to me, describing the moment. “The writing is on the wall: Lehman is dead. So one nanosecond later they’re looking for the next trade: How can we make money? And the way we can make money is by marking everything down and getting Barclays to give us big bonuses.”
That Sunday evening McDade placed a phone call to Bob Diamond, over at Barclays, and asked if he was still interested in doing the humiliating fire-sale transaction. Diamond said yes, and told McDade to set up a meeting for seven the next morning.
The next morning all the principals from both sides gathered—minus Fuld, of course—at Lehman’s offices on 745 Seventh Avenue. And they started working on a deal. Well, two deals actually.
On the morning of September 15, 2008, the surviving principals at Lehman huddled and began working on two merger-like deals—a real one, which was a straight-up pillaging heavily tilted in Barclays’s favor, and, unknown to most all the people working on it, a fake one, more seemingly equitable, full of careful math and dressy contractual bells and whistles about obligations to Lehman employees.
A veritable army set to work on the fake deal, early that Monday morning. Ad hoc workstations were set up on the thirty-second floor of the Lehman building, with rows of computers, phones, and work spaces put together on the fly. Hundreds of bankers, accountants, and lawyers from both the Lehman and Barclays sides ran back and forth, preparing to crunch numbers for a massive sale.
All this would turn out to be for show, although the people in those workstations didn’t know it.
Ostensibly, the huge teams of Lehman and Barclays employees were trying to arrive at a real-world price for the stuff Barclays was planning to buy. The transaction was not going to be an outright merger with Lehman Brothers; it was going to be an asset purchase agreement, which was much better from Barclays’s point of view, since it meant it got to just buy the stuff it wanted and let the rest of Lehman go down the toilet of the bankruptcy bureaucracy.
In order to do that, Barclays had to settle on a price for all the stuff in Lehman’s financial warehouse, which was why all those bankers were crunching numbers at full speed, trying to price Lehman’s books. And at the end of that Monday, all those hundreds of people in those thirty-second-floor workstations did in fact come up with the rough outlines of a deal. They came up with what is called a “book value” for Lehman’s inventory—a value that matched what Lehman’s Treasury bills and mortgage-backed securities and currencies and other stuff, all mashed together, might have fetched on the street.
What they did was, they found $70 billion worth of stuff that was actually worth something (assets) and then matched it to $70 billion worth of bills Lehman still had to pay (liabilities). What Barclays was supposedly getting, therefore, was a matched set of good stuff and bad stuff that had a net total value of zero. It would then pay the fire-sale price of $250 million for the Lehman name and business.
This was the deal that would be presented both to the Lehman board and to Judge James Peck’s bankruptcy court. This deal was designed “for posterity”: for the eyes of the Lehman board, the judge, and the outside world. It was, outwardly, a pretty good deal for both sides under the circumstances. Barclays would take on a matched set of billions in assets versus billions in liabilities, and for its trouble would get to take over one of the oldest broker-dealer businesses in America for a few hundred million bucks.
The value for the public was that the economy wouldn’t be further destabilized by an outright collapse (which, who knew, might necessitate further bailouts), while there was considerable value to many Lehman employees and executives in being able to continue working, see deals to fruition, rescue careers.
But what almost none of those hundreds of bankers and lawyers knew was that late into that first Monday evening and into the wee hours of the next morning of Tuesday, September 16, Diamond and a small team of his most trusted advisers had pulled a small group of carefully placed Lehman insiders aside and set to work cutting the real deal with them.
We’ll never know what might have happened had this second deal, which would be weighted far more severely in Barclays’s favor, been presented to the board. Who knows? It might have been accepted. It’s not like there was a parade of other buyers for the hulk of Lehman Brothers. But what’s crucial to understand is precisely that—that we’ll never know. The other players—Lehman’s creditors, the company board, the rest of the market—never got a chance to step up to the plate.
The second deal was struck very much in the manner of a political coup d’état. It was done with cinematic élan, before dawn. Bob Diamond secured the revolt by agreeing to pay a small crew of key insiders bonuses of millions of dollars apiece to do a secret job.
There were about a dozen of these insiders. They included McDade, who replaced Fuld as president, plus head of investment banking Hugh “Skip” McGee, equities chief Jerry Donini, CFO Ian Lowitt, Lowitt’s deputy (and the highest-ranking actual accountant at Lehman) Martin Kelly, the treasurer Paolo Tonucci, the fixed-income chief Eric Felder, the restructuring head Mark Shapiro, and a managing director named Alex Kirk.
Collectively, just the nine men listed above would be offered an astonishing $302.9 million that week. Technically, much of that compensation was supposed to cover other work done in 2008 and 2009 and beyond. But in reality, most of that $303 million was paying for their service in one deal.
The nine Lehman insiders, to put things in perspective, were offered about three times the compensation of the nine highest-paid New York Yankees that year. And they were essentially getting paid to play one game.
Just three of the principal negotiators—McDade, McGee, and Donini—managed to strike deals for an incredible $112,360,000 in future compensation among them. Many of the deals were struck at blinding speed and at very curious hours. Many of the insiders later testified that they got their windfall offers for future compensation as Barclays employees in the predawn hours of Tuesday, September 16, which by an extraordinary coincidence happened to be just in time to have their futures sorted out before they all went to a scheduled six a.m. emergency meeting of the Lehman board, where the Barclays deal was to be discussed and, ostensibly, approved.
Take Ian Lowitt, Lehman’s chief financial officer. A South African with a British boarding school education who had come to Lehman in the early 1990s by way of the McKinsey consulting firm, Lowitt had a crucial role in the company, and his cooperation was needed. Sometime before dawn on that Tuesday—before 5:10 a.m., according to his testimony—Lowitt received a call from Rich Ricci, one of Diamond’s chief negotiators.
Ricci told Lowitt that Barclays wanted to hire him, and that his compensation package would be worth about $6 million. Included in that package, Ricci told him, was a 2008 cash bonus of $4.56 million. That wasn’t pay for the work he’d already done that year at Lehman. It was pay for just three months of future work that year at Barclays.
When later asked for the reasoning behind that $4.5 million cash bonus for three months’ work, Lowitt testified that he was just that cool of a guy. He said he was “a valuable person for them to have as part of Barclays.”
Other Lehman executives got similar calls that morning. All would later profess to be confused by questions about what they had done to earn the money. Paolo Tonucci, who worked under Lowitt and would play an important role in completing the deal over the course of the rest of the week, was offered a cash bonus of $1.85 million and a “special cash award” of $700,000. When later asked what the money was for, he repeated Lowitt’s “value” line. “I assumed,” he said, “that it was going to a group of senior employees that Barclays felt would be of future value to the organization.”
Alex Kirk was offered $15 million. When later asked what he had done to earn the money, he had a hilarious answer.
Q: And what were your bonus arrangements or agreements with Barclays?
KIRK: About the end of October … they informed me that they would pay me $15 million in two separate installments.
Q: Did you receive either of those payments?
KIRK: Both.…
Q: Why did you get payments in the amounts that you did from Barclays having worked there for such a short period of time?
KIRK: I don’t know.
Martin Kelly, one of the senior bean counters in the company, and a man whose sloppy email habits would later play a key role in the case, received a package similar to Tonucci’s that included another “special cash bonus” of $700,000, and totaled about $1.7 million. When asked later in court if he knew what the bonus was for, Kelly looked in bankruptcy judge James Peck’s face and said he’d never asked.
Most all of these monster compensation deals were completed before dawn that Tuesday morning, just before that scheduled meeting of the Lehman board at six. Lowitt, Kelly, Tonucci, Kirk, McDade, and the rest of the insiders went to that meeting bursting with enthusiasm, suddenly ready to collectively give a big thumbs-up to the “asset purchase agreement.”
What they didn’t mention to the board was that they’d all just finished accepting multimillion-dollar bonus offers. Although the board was told that eight Lehman executives, including McDade, would continue to work at Barclays as a condition of the deal (these would later be referred to in the press and elsewhere as the “elite eight”), the board, again according to court testimony, was not told about other Lehman execs who had already cut future employment deals, like Kelly, Tonucci, and Kirk. The board wasn’t told about the predawn negotiations that very morning, and never had a clue that many of the people who would be working on the fine print of the pseudomerger were already, in effect, working for Barclays. When asked at trial a year and a half later why they had neglected to mention that information, many of these insiders offered parodies of nonanswers.
This is from Lowitt’s testimony. The questioning attorney here is Bob Gaffey of Jones Day, representing the Lehman estate.
GAFFEY: So I take it then, sir, you don’t have a recollection of speaking up at the board meeting and saying, I have some views about whether we should do this deal but I’ve just been approached by Barclays and they’ve offered me six million dollars. You don’t recall that? Having that thought process?
LOWITT: I don’t recall going to that board meeting.
This answer threw Gaffey. Almost any other story would have been swallowable, but here was the former CFO trying to say, with a straight face, that he didn’t remember, at all, the single most important meeting in the history of Lehman Brothers, which was incidentally the backdrop for the biggest bankruptcy ever.
AFFEY: You would agree with me, sir, that a board meeting of an iconic huge corporation—it’s just filed for bankruptcy, considering a transaction to sell substantially all of its assets—is a fairly big event in the life of a chief financial officer, do you not?
LOWITT: I wasn’t involved in negotiating the transaction. And I wasn’t involved in drafting the transaction. And so, I think that was probably components of why I don’t recall that board meeting. I was also, obviously, quite tired.
The insiders not only went through this board meeting without fully explaining their giant side deals, they boldly and enthusiastically presented the asset purchase agreement for the board’s approval, describing the deal as a “wash.”
Nobody seems to remember who used the term first, but multiple board members remember hearing it. Barclays, in other words, wasn’t making money on the deal. It was buying, from Lehman, a package that was equal parts good stuff and crap.
Board member Michael Ainslie, for instance, specifically recalls that concept because he and other board members had already been briefed on their new responsibilities—that they were now beholden to the creditors of Lehman’s estate and were charged with representing them at board m
eetings. “We had been briefed already that we were now working for the creditors,” he said. Hearing that the deal was a wash, he said, was a relief. “This deal structure seemed to eliminate the possibility of a loss to Lehman, or claims that would more than offset the value of the assets being transferred.”
Satisfied that nobody was getting shafted in the deal, the board approved it at that meeting on Tuesday, September 16.
The next day Harvey Miller of Weil, Gotshal & Manges, the lead lawyer for Lehman, went to federal bankruptcy court and presented the deal to Judge Peck for preliminary approval. Most people close to the case seem to believe that the Weil, Gotshal lawyers were genuinely in the dark about the secret deal, at least through the end of that week. And what Miller presented to the judge that Wednesday was the same deal: the wash of equal parts assets and debts.
Judge Peck saw the deal and approved it twice that week: once on Wednesday, and once on Friday afternoon. Between Wednesday and Friday, the structure of the deal was changed fundamentally—instead of a straightforward dump of assets and liabilities, the deal was now going to be centered on a complex three-way trade.
During the bankruptcy, the Fed had lent Lehman $45 billion to keep its doors open, and in exchange for that cash, Lehman delivered $50 billion in collateral to the Fed. Again, the mismatched numbers are normal in this sort of loan: the idea here was that if Lehman screwed up and couldn’t pay the cash back, the Fed would just swallow all that collateral, taking a little extra for its trouble, which also happened to be insurance in case of a poor valuation.
In the new deal between Lehman and Barclays, Barclays would take over the Fed’s repo, which dramatically complicated the deal. Still, even though the structure of the deal was totally different, the same concept of a wash was presented to Judge Peck. And sometime between one and two a.m. in the wee hours of Saturday, September 20, Peck signed a sale order that ended with a simple conclusion.