The Weekend That Changed Wall Street

by Maria Bartiromo

Pimco’s Mohamed El-Erian put it this way when we discussed it: “The problem was that they tried to run a commercial activity in a noncommercial setting. In the noncommercial setting, there were objectives related to increasing home ownership, with the expectation that loans were fully guaranteed by the government. In the commercial setting, Freddie and Fannie tried to maximize their profits. So you had a noncommercial context with commercial behavior, and as a result it became very unstable. The minute you bring in a noncommercial player, suddenly the incentive changes.”

  All along Mudd saw it as a structural problem. “Sooner or later, you need to resolve the business model,” he told me. “Right up to the end I was saying, ‘Let’s come up with a new structure.’ Because one way or the other, whether you like Dan Mudd or whether you like Frank Raines, or whether you like any of the leadership, it doesn’t matter. There’s been a whole series of good, bad, competent, incompetent CEOs running the place. And nobody has found it simple to do. That tells me there’s a business-model issue. Let’s resolve that, instead of just making it part of the federal government.”

  A contributory factor to the agencies’ problems was the mentality that every American had a right to own a home. This was the American dream, people said, never stopping to question whether such a goal was remotely realistic. The more that home ownership was wrapped in the flag, the worse things grew for the agencies charged with making the dream come true.

  On September 7 the government took control of Fannie Mae and Freddie Mac. There was very little controversy about the decision, but there was plenty of unease in the markets. The tentacles of the subprime crisis were extending into nearly every major financial institution. It could not be contained.

  The Monday after the takeover of Fannie Mae and Freddie Mac, I interviewed Hank Paulson, searching for clarity. The bailout had fueled a debate about the proper role of government. Was it appropriate to put taxpayers on the line when companies ran into trouble? Hank Paulson, I had learned from experience, was very good at talking lots and saying little, and on this occasion he seamlessly spoke in nonanswers, unruffled and unrevealing—until I asked a question about Lehman Brothers: “Are there plans afoot for a takeover of Lehman?”

  He got edgy and jabbed in the direction of his watch. “I’ve got to hop,” he said, suddenly in a rush, and ended our interview. Four days later he would summon the captains of finance to the Federal Reserve for a last-ditch attempt to rescue Lehman.

  It was nearly six months to the day since Bear Stearns was snapped up by JPMorgan Chase for a bargain price. Now it was déjà vu all over again—with one difference: how could Lehman have failed to gird itself for this predictable moment? I remembered so vividly the strong sentiment in the financial media and among my sources on Wall Street that the failure of Bear Stearns had set Lehman up for a grand fall. But what could Lehman do now to save itself before the end of a do-or-die weekend?

  Late on the evening of Friday, September 12, the phone rang in Dick Fuld’s office. It was Bank of America’s Ken Lewis, the man he most wanted to talk to. He didn’t have the phone on speaker, so those in the room heard only his side of the conversation, but it was obvious by his smile and his words that he felt as if he was hearing very good news. Fuld ended the call with, “Ken, I’m looking forward to being your partner. This is going to be a great deal.”

  He hung up and said, “It’s Bank of America. It’s going to happen.”

  Soon after, a source inside Lehman called me on my cell phone. “Bank of America is doing the deal,” he said with assurance. “I was in the room when Ken Lewis spoke to Dick. They were basically shaking on it over the phone. Ken gave Dick his home phone number, and they’re discussing the details in the morning.”

  My source was a good one, but was it plausible that Fuld had made a handshake deal with Lewis, even as the heads of JPMorgan, Goldman, Merrill, and others were engaged in a desperate effort to save his company? Maybe he thought he could be a hero cowboy and come riding in with the treasure strapped across his saddle. But the idea that Fuld had overcome Lewis’s resistance when Paulson could not sounded bizarre. Was it really happening?

  I remained on call late into the evening, trying to stay on top of events at the Federal Reserve. No one expected a resolution on Friday. We all expected a long weekend ahead. When I finally put away my phone and notes, it was long after midnight. I sat back and thought about what I was witnessing.

  I was also a citizen, and when I took off my reporter’s hat late at night, I gave in to my feelings of sadness that we had come to this point. For a long time the euphoria in the housing market had been troubling, because in my experience, euphoria came before a fall. Now that the fall was happening, I was deeply disappointed and personally shaken. I knew that whatever the outcome of the weekend, things would never again be the same for any of us. There was a lot of pain ahead.

  FOUR

  Down to the Wire

  “Let’s say we got together and saved Lehman. Do we then get together and save the next firm and the next firm? And is saving a weak firm undermining our own position in the market?”

  —A BANKER IN THE MEETINGS AT THE NEW YORK FEDERAL RESERVE, RECALLING THE ANXIETY HE AND OTHERS IN THE ROOM WERE FEELING

  SEPTEMBER 13, 2008

  Early Saturday morning, I reached the source at Lehman who had alerted me to the late-night phone call between Fuld and Lewis. He was staying at the Michelangelo Hotel, down the street from Lehman’s headquarters. “We finished around midnight, so I’ve only had about five hours of sleep,” he said.

  “So, do you expect to conclude a deal with Bank of America today?” I asked.

  “Yeah, we’re done,” he said wearily. He sounded more resigned than happy. “So we’ll be part of Bank of America. Who cares? At this point I want to say, ‘You can have the thing for free.’ Whatever. There’s no shareholder value left.”

  “How does Dick Fuld feel about it?”

  “Oh, you know Dick,” he said with a sad laugh. “Always the optimist.”

  “Will he survive the sale?”

  “Who knows? That’s above my pay grade. Look, I’ve got to run. Talk to you later.”

  I poured a cup of coffee and kept making calls. One was to my assistant. I was scheduled to fly to Naples, Florida, early Monday for the CME Global Financial Leadership Conference, where I would moderate a panel on the global credit crisis and interview former Fed chairman Paul Volcker. I told my assistant that the trip might have to be canceled, and she should be ready to make other arrangements. I was going to wait and see how things progressed that day.

  I called another Lehman source—this one a lower-echelon type who worked below the thirty-first floor. I wanted to get a sense of what the traders were saying. He, too, was heading into the office. Off the record, he confessed to feeling bitter toward Dick Fuld. “It isn’t just me,” he said. “A lot of us are questioning his judgment and wondering how we got into this mess. Everyone thought Dick walked on water. That was then, this is now. Why did he take so long to try to raise money? Why didn’t he see this coming? It’s hard to accept.”

  “What are you being told?” I asked. “Are people saying you should pack up your stuff?”

  “No, it’s kind of hard to get information. But I’ll tell you something. When I came to work for Lehman, it was as if all my dreams had come true. It was the greatest company in the world. So you can imagine how I’m feeling. And multiply that by thousands of others.”

  Ken Lewis, a native of Mississippi, enjoyed being outside the Wall Street club. His roots were lower middle class, and his story had all the elements of a rags-to-riches tale. His entire career had been spent at the Charlotte, North Carolina, headquarters of Bank of America, beginning in 1969, when it was called the North Carolina National Bank. A quiet man who masked his masterful business sense with a low-key Southern charm, he was fond of saying, “New York is a nice place to visit…,” leaving no mistake about the ending of the sentence. His office was six-hundred-pl
us miles from Wall Street, and he liked it like that.

  On Saturday morning when he awoke, Lewis had no idea that by morning’s end he would be hurtling toward the Big Apple in his private plane, preparing to do the deal of his life. And it wasn’t the deal that certain parties had anticipated.

  By 7:00 a.m., Lewis was on the phone with Hank Paulson, who was already at work at the Federal Reserve. He told the secretary that the more his people examined Lehman’s books, the worse they looked. Paulson replied that the consortium was still debating what they could take on, individually and collectively. He suggested that the consortium might be willing to come up with $40 billion to cover a large part of Lehman’s toxic assets. What did Lewis think about that? Lewis was unenthusiastic. He seemed to be retreating further and further from a deal. Once again, Paulson hung up, frustrated with the Bank of America CEO.

  The truth was, Lewis had decided he wouldn’t buy Lehman. While Dick Fuld may have slept better Friday night thinking he had a verbal agreement with Bank of America, Lewis already knew he had changed course and his company wouldn’t be making a deal. How to explain the phone call my source overheard? Maybe Lewis was still making encouraging sounds on Friday, even as he had privately decided against Lehman. But on Saturday morning he was avoiding Fuld’s phone calls, as the calls became increasingly frantic. When Fuld phoned the home number Lewis had given him, Lewis’s wife, Donna, answered the phone and said Ken wasn’t available. Fuld, still thinking he had an agreement with Lewis, and needing to work out the details, pressed Donna Lewis on the urgency, but she remained vague. Her husband, she told Fuld firmly, would have to call him back.

  Fuld waited as long as he could before putting in another call to Lewis. This time Donna Lewis sounded testy. “Ken has your message, and he’ll call you back if and when he wants to call you back,” she said.

  Fuld was embarrassed and apologetic. “I’m sorry for disturbing you,” he said. “This is the number he gave me, but I won’t call again. I’m sorry.”

  Meanwhile, John Thain awoke Saturday morning with one thought burning in his mind: Protect Merrill. Like Lehman Brothers and Bear Stearns before it, Merrill had its share of risky assets on the books. All the firms did. He was worried about market confidence. What if Lehman fell? Would the ripple effect bring down Merrill? He knew how dangerous the cycle could be. People would say, “Obviously, the assets are not worth what we thought,” and down they’d go. He didn’t want to be in a position of recovering pennies on the dollar. As he prepared to return to meetings at the Fed, he knew he had to be ready to take action to prevent his own company from losing liquidity if Lehman crashed.

  Saturday morning the Federal Reserve was a hive of activity. There were dozens of bankers and lawyers milling around, working at makeshift tables all over the lobby. At 8:00 a.m., Geithner and Paulson were on a conference call with Barclays CEO John Varley and chairman Marcus Agius in London and Bob Diamond at Barclays midtown office. Varley confirmed that Barclays was serious about buying Lehman, but they wanted to leave behind more than $50 billion in bad assets. Paulson judged that they were not bluffing. He wondered if he could convince the CEOs to come up with that number.

  When Paulson and Geithner emerged from the call, they headed into the conference room where the Wall Street heads were gathered, a little worse for wear after a short night.

  First on the agenda was a report from the group examining Lehman’s financials to determine how much money would be needed. Their conclusion: Lehman would have to raise $15 billion to $20 billion to make it out of the hole. This was a stunning amount of money. Remember, JPMorgan bought Bear Stearns for $4 billion. Would anyone pay such big bucks for Lehman? The group examining Lehman’s assets had a grim report. The assets were worth about $20 billion less than Lehman had calculated.

  The work groups were also finding some egregious examples of how bad it was at Lehman. These examples cut against the sense of entitlement that was prevalent at that time—that Lehman deserved a federal bailout. Clearly the firm had created the dire situation itself. “It was insane,” a participant in the meetings told me. “For example, in Dubai you had man-made islands that hadn’t been made, and people had bought houses on those islands and secured mortgages for them. But the islands didn’t even exist yet! There were a few situations like that and it was just devastating.”

  A Treasury official who was also in the meetings could not disguise his disgust. “I was pissed off because they were pounding us over our refusal to save Lehman,” he told me. “Well, those assholes created the problem.”

  There were too many holes in Lehman’s books, but Paulson urged them on. “We need to know where you guys stand,” he said. “If there’s a capital hole, the government can’t fill it. So how do we get this done?”

  The men around the table were feeling the strain. The idea that they would finance a competitor was anathema to them. But the concern went deeper than the question of whether the banks would be altruistic. There were serious long-term practical considerations as well. “Let’s say we got together and saved Lehman,” one banker speculated. “Do we then get together and save the next firm and the next firm? And is saving a weak firm undermining our own position in the market?”

  Lloyd Blankfein was particularly vocal. He assured Paulson that Goldman Sachs would do what was necessary and act responsibly. But what did that mean?

  For Thain, the meetings at the Fed were instructive on two counts: First, they convinced him that Lehman would not survive the weekend. The report on the financials confirmed it. Thain was also clear that Lehman’s fall would have a devastating effect on other firms, and Merrill was particularly vulnerable.

  At one point, Vikram Pandit looked down the length of the long table and pointed at Thain. “Who’s going to save them?” he asked. “Everyone knows if Lehman goes down, then it’ll be Merrill, and then it’ll be Morgan Stanley, and then Goldman.”

  Thain ignored Pandit’s provocative comment, but he was thinking hard about where he could get an infusion of capital. Paulson pulled him aside. The two men knew each other quite well from their shared years at Goldman Sachs. They’d been in tight spots together before. “I think you should call Ken Lewis,” Paulson said. He was facing the reality that Lehman had no real franchise value, but Merrill could be saved. “You have the thundering herd,” Paulson said with a smile. “Merrill Lynch has a lot of real value.”

  Thain considered what Paulson was telling him and nodded. “I know what I need to do,” he said.

  Barely nine months into his term as chief of Merrill Lynch, Thain wasn’t thinking about selling the company. He thought he could strike a deal with Ken Lewis for Bank of America to buy a 9 to 10 percent stake in Merrill. That would give Merrill breathing room to get through the crisis of Lehman’s fall.

  Determined, Thain stepped outside to Liberty Street, pulled his cell phone out of his pocket, and dialed Ken Lewis’s number in Charlotte. Lewis immediately took his call, although he’d been unwilling to take Fuld’s.

  “We should talk,” he told Lewis when he reached him. “I think there are some strategic opportunities here.”

  The two men didn’t know each other very well, but they were both speaking for their companies. Lewis, the consummate deal maker, had wanted to buy Merrill Lynch for a long time. Years earlier, Lewis had talked to the leadership of Merrill and had been willing to pay much more for the stock than it was currently trading. Now, in September 2008, he smelled a bargain. Perhaps this crisis was his opportunity.

  “I can be in New York in about three hours,” Lewis said.

  Saturday afternoon Thain and Lewis sat down together at Lewis’s corporate apartment at the Time Warner Center on Columbus Circle. It was just the two of them. Lewis confided to Thain that there would be no deal with Lehman. He’d made the decision the previous evening. Thain proposed that Bank of America buy a minority stake in Merrill—say, 9 or 10 percent.

  Lewis shook his head no. “I want one hundred percent,” he
said. “Or nothing.”

  Quietly, in another room at the Federal Reserve, a separate drama was occurring, with a potential damage far greater than the failure of Lehman or Merrill. It had to do with American International Group (AIG), the mammoth insurance and financial services firm whose tentacles reached into nearly every corner of the economy. As negotiations surrounding Lehman continued hot and heavy on Saturday, Paulson was working on another floor at the Fed, addressing the looming crisis at AIG. Chris Flowers, who had been at the Fed studying Lehman’s books on behalf of Bank of America, had also turned his attention to AIG, which he believed was in dire straits. Flowers laid out his papers on the table and began walking Paulson through the numbers. Paulson listened closely, but he was aware that Flowers was by no means a neutral party. Paulson suspected that he was interested in buying pieces of AIG on the cheap, and the board of directors had been resistant.

  Paulson and Flowers were former colleagues, too. In fact, it was beginning to feel like old home week for the Goldman Sachs alumni. Flowers had been a partner at Goldman during Paulson’s era and was now an incredibly successful private-equity investor who specialized in troubled entities. He was a billionaire who had made Forbes’s list of the 400 wealthiest Americans in 2006. Flowers wasn’t universally beloved, a reality that troubled him little. He once cheerfully referred to himself as a “low-life grave dancer.” He knew who he was. But he was also considered to have a top-notch mind, and it was hard to ignore his analysis when it came to AIG.

  “To be honest, AIG was the scariest one of all that weekend,” a Treasury Department source told me. “There was no real regulator involved. I mean, insurance was regulated in all fifty states, but there was no common regulator. I remember looking at Hank and saying, ‘We’re not going to save an insurance company, are we?’ He looked at me like I was crazy, because I had no idea the tremendous reach AIG had.” Incidentally, I later learned that there were four hundred agencies overseeing AIG, and they all missed the sizeable leverage at the company’s financial products division. Four hundred agencies! It wasn’t just the Wall Street executives who had dropped the ball. Regulators had messed up royally.