The Weekend That Changed Wall Street

by Maria Bartiromo

  Callan was livid—not just because Einhorn was shorting Lehman’s stock, but because he was attacking her so publicly. In an interview with me, she called on the SEC to investigate the predatory tactics of short-sellers like Einhorn. Fuld was also angry. He vowed to “hurt” the shorts.

  I wondered how valid Einhorn’s perspective was. I asked Brad Hintz, who had been Lehman’s CFO in the 1990s, putting it to him this way: “Einhorn is basically claiming that what Lehman said in the first quarter is not what it’s saying now with regard to its portfolio. He’s all but said Lehman is deceiving investors. Do you think Dick Fuld and Erin Callan have been as forthright as they might have been?”

  “If you’re asking me whether Lehman will win an award for best disclosure, the answer is no,” Hintz replied. “But I don’t think any brokerage firm will get that. Are there numbers gaps? Absolutely. I don’t doubt that. But I think the concerns from the shorts are overdone.” Hintz didn’t believe the risk to Lehman was that severe. “Lehman will not go down. We have the Federal Reserve behind it. By the Fed opening the discount window, it has injected a little bit of courage into the counterparties. So when Lehman says, ‘We’re not borrowing much from the Fed,’ that’s technically very true. But they are borrowing courage.” Ultimately, Einhorn proved to be right.

  As Lehman and other companies struggled, the people trying to hold them together were working overtime, exploring multiple options. It was complex and it was tricky. Fuld was frequently on the phone with the Treasury Department, discussing options. Paulson would later say that they spoke some fifty times between April and September. Paulson was often frustrated with Fuld, who he believed had trouble seeing and accepting reality.

  As one of Paulson’s cohorts told me, “It really became apparent over the summer that no one had the same view as Dick of what Lehman was worth. Now, I think Dick is a fine guy, but he just wouldn’t wake up and smell the coffee. We at the Treasury began to focus on Lehman Brothers immediately after Bear Stearns went down. We were in frequent touch with Dick. Actually, Dick was in India the weekend that Bear Stearns went down. And I talked to him two or three times in India that weekend and said, ‘You’ve got to get back. There’s going to be a laserlike focus on Lehman.’ But there were serious doubts about whether Fuld was getting the message.”

  If Fuld’s expectations seemed unreasonably high, it may have been because of his past experience. Ten years earlier, Fuld had been the hero who rescued Lehman when the collapse of the hedge fund Long-Term Capital almost brought the firm down. He believed he could pull off another rescue.

  In the early summer Lehman was in discussions with several potential strategic international partners. Fuld had long been interested in developing a collaboration with a foreign company, with the partner taking a 5 to 7 percent stake in Lehman.

  “Every weekend we were at the office, busted up into teams, discussing options,” a former Lehman executive told me. “We thought we could do any number of things. For example, if for the third quarter, instead of announcing the numbers we did, we’d reported having sold $10 billion of the risky mortgages and now had no mortgages on the books; or if we had announced a spin-off with $10 billion in equity, and the debt on the books was guaranteed by JPMorgan; or if we’d sold the investment management division for $6 billion and made a profit, and our leverage was strong and we’d be good to go. Or if we’d announced that we got a $10 billion investment from Korea Development Bank, or we’d sold the company to Bank of America, everyone would be applauding us. These were all valid options under consideration.”

  Then something inexplicable and shattering occurred that put a huge dent in Lehman’s credibility. On Wednesday, June 4, a story appeared in the Wall Street Journal, “Lehman Is Seeking Overseas Capital: As Its Stock Declines, Wall Street Firm Expands Search For Cash, May Tap Korea.” The story highlighting Lehman’s liquidity problems was written by business reporter Sue Craig, and it cited a source high up in the executive office. This was potentially devastating for the company because it proved Lehman needed cash. Who would talk to the Journal, especially to reveal such a strategy? That day Lehman’s stock dropped like a stone, leaving the top executives baffled and horrified.

  Scott Friedheim had a vague suspicion of who might have been Craig’s source. That morning, Erin Callan came into his office and sat down. It was the first time she’d ever done that. Dick Fuld and Joe Gregory did it all the time. Callan never did. And she said, “What do you think of the Journal story? Do you think our stock is going to go up?”

  Friedheim stared at her, bewildered. “No,” he said, “I don’t. I think it’s going to go down.” He couldn’t believe she would see it that way, but her presence in his office raised his antennae. Why was she so eager to put a positive spin on it?

  Dick Fuld was out for blood. What really got him was that he’d just spoken with Craig a week or two earlier. She’d called him and said, “I want to come in and sit in on one of your strategy sessions with your senior management team.” She’d told Fuld that she was interested in getting an honest, and by implication, favorable picture of Lehman. Fuld said he couldn’t let her sit in on actual strategy sessions, but he’d figure something out and get back to her. Then this happened. Feeling betrayed and blindsided, Fuld called Craig. “You posed as a friend of the firm,” he said angrily, “and you’re not what you said you were. You went behind my back, deceived me, and printed something that wasn’t even true, and I’m not going to deal with you or the Journal again. We’re through.”

  He slammed down the phone and turned to Friedheim. “Scott, no one in the firm talks to the Journal. That’s it.”

  As Friedheim left Fuld’s office, he continued to puzzle about the source of the story. Fuld had been so angry he hadn’t thought to ask Craig. But as soon as he got back to his own office, Friedheim’s phone rang. It was Kerrie Cohen, in public relations.

  “Hey, Kerrie, what’s up?” Friedheim said, distracted.

  She said, “I just got the strangest call from Sue Craig.” Friedheim sat up straight, now paying close attention.

  “What did she say?”

  “She was very angry,” Cohen said. “She said, ‘I just got off the phone with Dick. You have Erin call me immediately.’ And then she hung up on me.”

  Now Friedheim felt it was likely that Callan was behind the Journal story. She’d apparently assured Craig that she was speaking with authority, and the reporter felt as if she’d been unfairly slammed by Fuld. Senior executives then checked the firm’s e-mail records and said they found evidence that Callan had been talking to Craig.

  I never had direct confirmation that Callan told Craig about the outreach to Korea and the possibility of a capital raise. But key people at the firm had their minds made up. It was the final self-inflicted wound Callan would sustain. In July she was forced out of Lehman.

  I had Callan’s cell phone number, so I called her when I heard the news. “Erin, it’s Maria Bartiromo,” I said when she answered. “I’m sorry about what has happened. Can you talk to me a little bit about what’s going on?” She sighed and said, “Look, Maria, I’ve been crying all day. I’m sitting in the Hamptons having a glass of wine, and I’m done.” Her voice trembled. “I can’t stand them,” she said.

  “I want to keep in touch,” she told me, and I agreed. We scheduled dinner for a month later, but she canceled a few days before the date. Although I had always been fair with her, I think Callan was in media-avoidance mode. No surprise there. Soon after, she joined Credit Suisse as managing director and head of the hedge fund business. She worked for only five months before taking an indefinite leave of absence and disappearing from public view. We didn’t speak again.

  The siege continued into 2008. “We had five months of total fear,” Larry Fink, CEO of Blackrock, the largest asset manager, would confess to me later. He described a scenario that was nearly unprecedented, a dramatic loss of confidence in the markets. The conventional wisdom has always been that the marke
ts are all-knowing—that there’s an innate wisdom that never gets questioned. But suddenly, Fink explained, “the marketplace was frightened. Everything was very uncertain. The fear was quite large. I remember having dialogue with others—‘Can we save all the companies? Should they all be saved?’ Everyone wanted a positive resolution.”

  In fact, they were desperate for one. In interviews throughout the summer, I kept hearing shaky hope. The spin was nonstop. Everyone was using a baseball analogy to express some optimism. “We’re in the eighth inning, Maria,” they’d say. “We’re in the bottom of the ninth.” But when I spoke with Brad Hintz in June, he just laughed and called it a miscalculation. “A lot of the managements in these firms are saying, ‘We’re in the seventh inning…we’re in the eighth inning.’ The problem is, no one told them it was a doubleheader.”

  “It wasn’t just Lehman on the line,” an executive there told me. “Investment banking is a confidence game. If the market has zero confidence, every single one of us with this model is dead. It’s not because we’re bad firms.”

  The damage went beyond the banks, though. The growing mortgage crisis was also shaking the foundations of the large and sacrosanct Fannie Mae and Freddie Mac.

  Dan Mudd, the head of Fannie Mae, found himself swept up in events during the summer of 2008. Mudd, fifty-two, the son of famed television newsman Roger Mudd, had been at Fannie Mae since 2000, and it had been a somewhat rocky tenure. A decorated Marine who served in Beirut, Mudd had established a solid business reputation internationally before he came to Fannie Mae, including serving as president of GE Capital Asia-Pacific and GE Capital-Japan. One day in early 2000, he received a call at his office in Tokyo from a headhunter, asking if he’d be interested in interviewing at Fannie Mae for the position of chief operating officer. Fannie Mae, an acronym for the Federal National Mortgage Association, was a government-sponsored company, chartered by Congress to provide liquidity, stability, and affordability to the housing market. Millions of Americans had mortgages through Fannie Mae and its counterpart, Freddie Mac (Federal Home Loan Mortgage Corporation). They were, in many people’s eyes, the standard-bearers for the American dream.

  Mudd said he wasn’t interested in making a move, but the headhunter pressed him. “Why don’t you at least talk to them, have breakfast or something the next time you’re in Washington,” he said. It turned out that Mudd was headed for Washington that week for his parents’ fiftieth anniversary. He figured why not; he had nothing to lose. He arranged an interview with CEO Franklin Raines.

  Raines, an accomplished businessman a few years older than Mudd, had an impressive résumé. He had been vice chairman of Fannie Mae for several years before joining the Clinton administration as the director of the Office of Management and Budget. He then returned to Fannie Mae as CEO once he’d left the administration. Raines’s personal story was well known to Mudd. He was a classic example of someone who had pulled himself up by the bootstraps. The son of a Seattle janitor, he was the first African American to run a Fortune 500 company. But the initial meeting between Raines and Mudd did not go well.

  “It was the worst interview of my life,” Mudd later told me. “There was no chemistry, nothing there. The conversation didn’t flow. It was like pulling teeth to get any answers from him.” He left the interview shaking his head in disbelief. It had seemed like a colossal waste of time.

  Mudd went back to Tokyo and forgot about it, but to his amazement, the headhunter called him a couple of weeks later and said, “Raines really liked you.” He suggested that Mudd meet with board members and other principals.

  The more Mudd thought about it, the more attractive the notion of moving back to Washington became. His parents and siblings lived there, and now that his children were approaching their teens, he thought it would be nice to be in the bosom of the extended family once again. He was also attracted to the job, to the idea of getting more involved in public policy, albeit in a market-oriented way. He believed he could make a contribution. He decided to take the plunge, and he started at the company in the winter of 2000.

  It was a difficult adjustment. The pseudogovernmental nature of Fannie Mae was anathema to Mudd, who had always been a straight shooter in business. He had problems with the culture, the sense of secrecy, the constant need to double-check decisions for political implications. On a couple of occasions he almost resigned. Something seemed off about the agency, and off about Raines. In particular, Mudd found Raines’s incessant lobbying and attempts to politicize his office distasteful.

  In December 2004 he found out that his instincts were correct. He was sitting in his office when he received a call from Ann McLaughlin Korologos, the lead director. Korologos, the tough, no-nonsense former Labor secretary, and a member of several boards, was a consummate Washington insider. She got right to the point. “Dan,” she said, “I need you to come down to the Four Seasons in Georgetown. We are going to dismiss Mr. Raines and several others. Before we do that, we need to know whether you would be willing to serve as the interim CEO.” Mudd was speechless. He couldn’t believe what he was hearing.

  “She said they didn’t know whether I was a good guy or a bad guy—or words to that effect,” Mudd recalled. “But, at least for the moment, I was all they had, and they needed somebody to be running the place.”

  Mudd agreed to meet at the Four Seasons restaurant in Georgetown. It was very cloak-and-dagger. Korologos instructed him to go in the side door where someone would meet him, and he went in and waited. When he sat down with Korologos and other board members, he saw that the situation was dire. Fannie Mae was in disarray. There were massive accounting errors, understating losses by about $9 billion over the past three years. Someone had to stick around and clean up the mess, and Mudd was elected.

  By then it was questionable whether anyone could turn around the massive enterprise, which had for so many years operated as its own private kingdom, outside the reach of regulators. Raines and his lieutenants were being criticized for amassing personal wealth at the expense of an agency meant to serve average Americans. In 2006 the Office of Federal Housing Enterprise Oversight (OFHEO) filed charges against Raines and two other former executives, alleging fraud and seeking $110 million in penalties and $115 million in returned bonuses. But in a 2008 settlement, the three men agreed to a mere $3 million in fines—and that would be paid by Fannie Mae’s insurance company.

  The next two years were intense as Mudd supervised the largest restatement that had ever been done, and returned Fannie Mae to responsible accounting practices. Impressed by his work, the board offered to make Mudd permanent CEO. Mudd had always planned to leave once the mess was cleaned up, but he had grown more comfortable with Fannie Mae’s culture, and his family loved being in Washington. “Okay,” he said, “I’ll stay and give it my all.”

  And then the housing market imploded.

  Like every other entity holding mortgage securities, Fannie Mae was forced to address serious issues of liquidity and toxic assets during 2008. By August alarm bells were ringing about how undercapitalized Fannie Mae and Freddie Mac were. Even so, their regulator had given them a pass that summer. Then, right before Labor Day, Mudd received a puzzling letter from the Federal Housing Finance Agency (FHFA) detailing serious capital issues. “The letter basically said, ‘I’ve changed my mind. I now think you have serious capital issues.’ It was weird,” he told me.

  Mudd picked up the phone and called Secretary Paulson, and that was weird, too. “What’s going on?” he asked Paulson. “This is different than the good-faith discussion we had two days ago.”

  “I can’t talk,” Paulson said. “We’re setting up a meeting.”

  Mudd, accompanied by his board chairman and general counsel, headed over to the FHFA offices for the meeting. As they were standing in the reception area waiting to be called, Ben Bernanke walked in.

  “How’s it going?” he asked Mudd in a friendly tone.

  “Good,” Mudd replied. “How’s it going with y
ou?”

  “Good, good.”

  “Nice weekend. Weather was pleasant.”

  As Mudd told me later, “It was totally pathetic. The world was in flames, and we were talking about the weather.”

  At a meeting upstairs, joined by Paulson, Mudd learned his fate. The federal government was taking over Fannie Mae and Freddie Mac. “We’re going to declare conservatorship,” Bernanke said, “and we want your whole board to be here tomorrow morning. We need a decision in twenty-four hours, and if you don’t want to do it the easy way, we’ll do it the hard way.”

  Just like that, Mudd was out. Over at Freddie Mac, CEO Richard Syron was hearing the same news. It was a done deal.

  “Some people thought Fannie was a bit stronger than Freddie; others thought it wasn’t stronger than Freddie. Some even argued that Fannie was weaker than Freddie,” a source at the Treasury told me. “So there was some discrepancy in terms of how they stood. But the bottom line was that they were both sufficiently weak, so that as a result of the assets that they were holding, they were going to be in trouble very soon. In fact, they were already in trouble, desperate trouble. So we knew that we were going to be stuck with the bill on Fannie and Freddie. And then the question was what to do with it.” Even the most market-oriented people at the Treasury favored conservatorship, because Fannie and Freddie were not full-fledged market institutions anyway.

  “It was essentially the worst of both worlds there,” my source said. “We had a nonmarket entity with government backing that was behaving badly. I think we all agreed that it was time for those guys to go under. Maybe their role had been important once, but many of us thought they had become obsolete.”