The Weekend That Changed Wall Street

by Maria Bartiromo

  In a crisis, Geithner made a good partner for Paulson, who was known to be emotional and passionate. In office just under two years, Paulson brought almost a religious fervor to his job; he felt he was there for a purpose.

  Unlike Geithner, Paulson was the epitome of a Wall Street man. Before President Bush nominated him for the Treasury, he was the chairman and CEO of Goldman Sachs, a firm he had joined back in 1974. A Christian Scientist and a family man, he was a quiet, though influential, player in corporate America long before becoming secretary.

  Paulson’s job, arriving at the Fed, was to convince the CEOs that the solution was up to them. “Everyone thought good ol’ Hank would be there with the money as he was with Bear Stearns,” a source at the Treasury told me. “And they weren’t going to believe otherwise until Hank told them in person.”

  In truth, the federal government did not have the authority to lend money to failing institutions, only to institutions that were solvent. The reason a Bear Stearns backstop had been possible in March was because a highly solvent institution, JPMorgan, took over. The Fed could not have loaned money to Bear Stearns directly, but it was able to do so with JPMorgan’s help. Paulson was essentially paving the way for a similar setup with Lehman Brothers and a solvent savior such as Bank of America or Barclays—with one difference. He wanted the backstop to come from the private sector.

  The third man on the team, Christopher Cox, was the “grim reaper.” His primary task was to shepherd Lehman Brothers through a bankruptcy proceeding, if that was to become necessary. At fifty-five, Cox had worn many hats in his career, including a stint at the Reagan White House and seventeen years as a California congressman. The accomplishments of his professional life were set against the backdrop of remarkable personal crises that underscored his ability to make a comeback. In 1978 he was paralyzed from the waist down in an off-road Jeep accident. He eventually regained the use of his legs, though he was often in pain, even thirty years later. Then, shortly after he became SEC chairman, Cox was diagnosed with cancer. He battled the illness while maintaining a heavy work schedule, and by 2008 was deemed fully recovered.

  But while there was much to admire about Cox personally, a chorus of criticism followed him throughout 2008. As the government’s primary watchdog, the SEC looked ineffectual in its failure to spot the looming crisis and prevent it. As he joined Geithner and Paulson at the Federal Reserve, Cox had to know his reputation was on the line.

  The CEOs were sitting around a long table in the conference room on the first floor when Paulson, Geithner, and Cox walked in. The mood was restless and uncertain. These men were not accustomed to collaborating, and while the call to do so was not completely unprecedented, it wasn’t something you’d see in other industries. Imagine, for example, General Motors and Ford being pressured to save Chrysler, or NBC and Fox forking over the funds to save CBS. It just wouldn’t happen. But the financial industry was more interrelated. One drowning company could sink them all. Faced with that reality, they had to put aside their modus operandi—to try to kill one another—and start to work together.

  Ironically, the last time the Wall Street companies had been called upon to rescue one of their own, Lehman Brothers had been deeply involved as well. It was 1998. Robert Rubin was Treasury secretary, William McDonough was New York Fed president, and Dick Fuld was four years into his tenure as Lehman CEO. A giant hedge fund called Long-Term Capital Management was on the brink of collapse, having lost $4.6 billion in the space of a few months. Since most of the Wall Street firms had ties to Long-Term Capital, the Federal Reserve feared that a failure would have a traumatic ripple effect. In particular, Lehman was vulnerable. The Wall Street firms got together in a consortium and put their money on the table. Several firms pledged $300 million each, including Barclays, Chase, Goldman Sachs, Merrill Lynch, Morgan Stanley, and JPMorgan. Fuld pledged $100 million on behalf of Lehman, saying he couldn’t afford to do more. Long-Term Capital Management was saved, and Fuld got a lot of credit within his own company for bringing Lehman back from the brink. Notably, Jimmy Cayne at Bear Stearns refused to give any money, irking his colleagues.

  Geithner opened the meeting. In his quiet, unemotional voice he laid out a gloom-and-doom scenario of what a Lehman fall might mean for the rest of them. Paulson spoke second, telling the men flat out that he didn’t have the legal authority to save Lehman. That was up to the people around the table. Initially, there was push back. Wasn’t there something the feds could do, without having to rely on the banks for a rescue? But very soon these men, who were top professionals, pivoted and said, “Okay, how can we manage this?” They had all done deals with Hank Paulson in the past, and one thing they knew about him was that when he said “We’re not bailing Lehman out” he meant it. Paulson never showed his gun without using it.

  Chris Cox spoke last, describing how the SEC would manage a bankruptcy, if one were to happen. No one wanted to go there, but it was Cox’s job to take them if necessary.

  Although all the news and theorizing were about Lehman, Fuld was nowhere to be seen. He wasn’t invited to the Fed because the discussions were about him and his firm. But that didn’t mean there wasn’t a lot of speculation about what he was up to. Moody, passionate, and proprietary about his company, Fuld was fully engaged on the thirty-first floor of the Lehman Brothers building at the top of Times Square. His lieutenants were at his side, trying to work every last-minute angle. Those close to Fuld said that he believed with all his heart that if things turned bad they could orchestrate a deal similar to that of Bear Stearns. It never occurred to anyone, least of all Fuld, that the government would not be there to catch Lehman if it fell. An aura of denial filled Lehman’s executive suite in the period leading up to the end.

  Behind the drama being played out on Liberty Street and in midtown Manhattan was a fact few people realized. There was some personal animosity between Paulson and Fuld, based on their different backgrounds and temperaments. Paulson was a lifetime investment banker; Fuld was a lifetime commercial paper trader. A source told me of a dinner between the two men in the spring of 2008. “A lot of people in the press thought it was a warm and fuzzy dinner,” he said. “But it was actually very intense. At one point Dick Fuld lectured Hank Paulson, saying, ‘I’ve been in my seat a lot longer than you’ve been in yours. Don’t tell me how to do my job.’” How ironic that a few months later, Fuld would be so reliant on Paulson’s good graces.

  Even before it reached full-crisis mode, Lehman had developed a credibility problem, and everyone in the room knew it. I, too, had been hearing the whispers for months. Larry McDonald, who was a vice president and a trader at the firm until 2008, did not mince words when he spoke to me of his former company; no question that as a “worker bee” at the firm, McDonald had an ax to grind. He had become one of the harshest critics of Lehman’s culture, even writing a book about it in 2009—A Colossal Failure of Common Sense. His view was not unbiased, but it did show how embattled many people down the ranks were feeling at Lehman during that period.

  “There was a disconnect between the men in the ivory tower and the wonderful people who worked at the firm,” he told me. “Lehman Brothers, to me, was never rotten at the core. That’s where all the beauty was. It was rotten at the head. There was so much talent in the middle that tried to stop the madness. One by one, those who spoke up were silenced. At Lehman, you kept your head down and you did your job, or you lost both.”

  McDonald painted a picture of a fiefdom where those in the royal suites were more interested in the aura of their personal wealth than the health of the company, and he said that this was especially true at the seat of power—the thirty-first floor of the Lehman building. “The thirty-first floor is one of the most mysterious places on earth,” McDonald confided to me. “Some people claim it resembles a Sotheby’s art collection facility—or a cross between that and a human resources pom-pom bonfire festival. You had people up there who were totally distanced from the trading floor, very conc
erned about their new memberships in the billionaires’ club—or I should say the $200 billion art club.” (In fairness, the space, including the art collection, was not unlike those of most Wall Street firms, but if viewed through a prism of disappointment and resentment, the lavish atmosphere might grate.)

  McDonald claimed that Fuld took his eye off the ball years before the collapse, while many in the lower echelons of the company were issuing dire warnings. “As early as 2006, some of the most talented people at Lehman wanted us out of the subprime mortgage business,” he said. “We started seeing weird things happening—such as people missing their first mortgage payments. That was unprecedented. There was something wrong. It was like a slow-motion car wreck.”

  Certainly, Fuld had his defenders at the firm. “To say Dick was not engaged is nonsense,” one of them told me. “Leading up to mid-September, he was working around the clock to save the firm. And he was getting absolutely no help from the SEC in dealing with the shorts and the rumors, or from other banks. Look at JPMorgan. They were the bank that facilitated Lehman’s trades. There’s a clause in the contract that basically gives them the right to ask for however much collateral they want. So they just started grabbing more and more and more collateral. And it was devastating.”

  Robert Diamond was not a particularly emotional guy. His long face was pleasant but inscrutable. The president of British-owned Barclays Capital was known to be a cagey player, with the placid air common to members of large families. One of seven children, Diamond grew up in Concord, Massachusetts. Both of his parents were schoolteachers. Although Barclays was Britain’s premiere bank, Diamond retained an abiding love and loyalty for the home teams—the New England Patriots and the Boston Red Sox. He was, beneath the British flag, a quintessential Wall Street guy, who had cut his teeth at Morgan Stanley and had joined Barclays only after being passed over for the top job there.

  On Friday, September 12, Diamond’s normally calm demeanor was shaken by the weight of phenomenal responsibility. He felt uncommonly emotional as he sat in a room on the fourth floor of the Federal Reserve, away from the main conference room where the CEOs were gathered. Diamond thought that he, in particular, was on the line because many people were looking to his company to rescue Lehman, and he just didn’t know if it could be done.

  For more than a year Barclays had been actively pursuing growth in the United States, looking for the right vehicle. After the Bear Stearns fire sale, it occurred to Diamond that perhaps it could be the template for a deal, and the firm that came to mind was Lehman Brothers. He thought, “What an incredible opportunity.” He salivated thinking about Lehman’s thirty-two-story building and its ten thousand New York employees. But he wanted a distress price, and he wanted a government backstop—just like Jamie Dimon of JPMorgan got for Bear Stearns earlier in the year.

  Diamond had many unofficial conversations with Hank Paulson and his people as the summer stretched into fall. These were “what if” discussions as Diamond felt his way on matters of procedure and price. In the days before the final weekend, the discussions intensified. Thursday, September 11, a team from Barclays had begun doing their due diligence, taking apart Lehman’s books, and they would continue, sleepless, throughout the weekend.

  “It was clear to us that this was a fantastic franchise,” Diamond recalled to me. “The scope of its business was impressive and many were operating very well.” But the drawbacks were just as striking, and they all boiled down to one reality: Lehman had no liquidity.

  Now Diamond was feeling the stress. He was not a poker player, and this was a beads-of-sweat-inducing moment. “It was stressful. It was emotional,” he told me later. “We realized we were playing for big stakes. So, on one hand, we knew that if Lehman went into bankruptcy, there would be huge implications in the market. On the other hand, we wanted to look at whether or not there was a transaction that made sense for Barclays, as well as for the markets.”

  The problem: Hank Paulson’s insistence that there would be no federal backstop, no bailout, no sweet Bear-style deal. Bob Diamond wanted Lehman. But could it happen? Would his own regulator, Britain’s Financial Services Authority, allow a sale?

  John Thain had been riding high for some time. His career was on a fast track. He was savvy and cerebral, with a square jaw and a bland demeanor, and a résumé that was rock solid. Thain had been president and co-chief operating officer at Goldman Sachs before becoming CEO of the New York Stock Exchange. He had held the top job at Merrill Lynch for only nine months. When he was brought in to replace the retiring chief executive, Stan O’Neal, everyone on Wall Street had been surprised. The scuttlebutt was that Thain would be tapped to replace Chuck Prince at Citigroup and that Larry Fink of BlackRock would take over Merrill. But I was told that Fink would not entertain the idea unless he was allowed to review Merrill’s balance sheet and accounting, a reasonable request that the board denied. So Thain was the choice. He was hired to strengthen a rudderless company, as he told me in November 2007 when he started his new job. “The board is looking for leadership,” he said. “The board is looking for strategy and direction. The board is looking to unify the company.”

  From the outset Thain was aggressive in his efforts to strengthen Merrill. His first task was to get rid of the bad assets on Merrill’s books. He brought in highly paid, talented executives—many of them former colleagues from Goldman Sachs. Among them was a top examiner whom he paid $40 million to clean up the books. Hearing about the exorbitant number, I asked Thain, “Is it true? How do you justify bringing this guy over and paying him so much?” Thain defended the idea. “That’s right,” he said. “I’m going to pay him. He’s a talented guy, and I am going to pay top dollar to ensure this never happens again.” It was a huge payday for the examiner, who wound up staying three months.

  Now, sitting at the Fed, Thain listened carefully to what was being said. For Thain and his colleagues it was glaringly apparent that much more was at stake than just the future of Lehman Brothers. This was a massive wake-up call, a thump on the head to all the Wall Street firms. It was no longer about one firm failing—be it Bear Stearns or Lehman—it was about the tangled interconnectivity. The major Wall Street firms were like climbers roped together on an icy slope. Earlier that day, Merrill’s board of directors had a conference call with Thain expressing concerns that the short-sellers would be coming after Merrill next. No one was immune. “I’d better figure out how to protect Merrill,” he thought, “or we could be next.” Although Thain had assured his board that Merrill was no Lehman, he could envision a similar downward spiral occurring, especially if the short-sellers set their sights on his firm, creating a run on the bank.

  Paulson and Geithner were pushing the top firms to share the burden. Politically, Paulson didn’t think he could save another Wall Street firm. There was too much pressure, especially from Republicans in Washington, to not bail out anybody else. He wanted the rescue, if there were to be one, to come from Lehman’s counterparts.

  “We have to figure out what needs to be done here,” Paulson told them. He outlined the options, including potential mergers. Lloyd Blankfein, CEO of Goldman Sachs, thought things were moving a little too fast. “All right,” he said, preparing to leave, “let me think about this and I’ll get back to you. I have to speak to my board.”

  “Yeah, you can think about it,” Paulson replied, pointing in the direction of meeting rooms down the hall. “Take a room. We’re going to fix it this weekend. You’re not going anywhere. If you need to talk to your boards and bosses, you’ll have privacy. But we’re doing it this weekend, before the Asian markets open Sunday night.”

  Morgan Stanley’s John Mack sat gloomily at the table, feeling that the March sale of Bear Stearns had been a dress rehearsal for the big show that was now happening before him. He had spoken to Dick Fuld on several occasions in recent months, trying to figure out if there were things that could be done—assets that could be purchased, even a merger. But nothing was clicking. “
You had this sense,” he told me later, “that we were all tracked for some change, especially Lehman. What that meeting brought to the forefront was the reality of it and the impact of it. I don’t think we fully understood until then how bad it really was. The question was, how did you contain this contagion? Could you build a buffer that stopped with Lehman?”

  Mack contemplated the possibility that the markets really could melt down. He didn’t feel scared, but the determination was growing in him, and he could see it in others around the table. They had to fix this problem.

  Robert Wolf, chairman and CEO of UBS Group, had received the call from Geithner’s office at 3:30, saying, “Please come down. There’s going to be a meeting.” He replied, “Can you tell me what this is in reference to?” The person on the line wasn’t too forthcoming except to say, “If you need to invite someone, I’d recommend bringing your chief risk officer.”

  Wolf chuckled, remembering the call. “Obviously, some people were more in the loop than I was, because they’d been engaged earlier by the Fed or by Lehman.”

  Citigroup CEO Vikram Pandit was not entirely clear why he had been summoned to the Federal Reserve, but he could feel the buzzing sense of urgency as soon as he arrived. Pandit had joined Citi in 2007 when it acquired his hedge fund, Old Lane Partners, for $800 million, and almost immediately got bumped up to the top position after Chuck Prince was forced to resign. Now, sitting across the table from Paulson and Geithner, surrounded by his peers, he sensed the dread in the room. This wasn’t just about one company, he realized.

  Prior to that day, there had been a lot of argument over possible solutions—government assistance, buyouts, and mergers. But on Friday, September 12, it sank in that a Lehman bankruptcy would have ripple effects, and the key players realized they needed to stop bickering and try to figure out answers.