Part 17 (1/2)

At that moment the Lehman negotiators had their backs to the wall down at the concrete fortress of the Federal Reserve on Liberty Street, which, ironically, stands atop the biggest stockpile of gold bars on earth, surrounded by every kind of security, machine-gun-toting armed guards, and metal detectors. Bart, Alex, and Jim Seery fought for the life of the old investment bank they all loved. But they had to fight in the lair of Hank Paulson, and they suspected he had already decided to let Lehman go. He had creatively saved Bear Stearns but would not do anything for Bank of America in their attempt at a Lehman takeover, and he was not about to help Barclays. The Brits still seemed to want something of Lehman, though not everything, and early Sat.u.r.day, having been there most of the night, they said a deal was possible, but they needed the approval of the Financial Services Authority (FSA), the British regulators in London.

Meanwhile, on another floor, Hank Paulson was in conference with Bank of America officials in their efforts to buy Merrill. To this day there are those who believe Hank was more interested in saving Merrill than he ever was in saving Lehman. Every few hours he fielded a call from Fuld, but the fact was, he disliked the man, and he believed that Lehman had arrogantly foisted most of their troubles upon themselves and should just go away.

Warnings that such a failure might lead to a world banking collapse concerned him but did not quite convince him he should step in and rescue them both. Hank took aside John Thain, his old friend and colleague from Goldman, now CEO of Merrill, and gave him a stern talking-to. Moments later Thain called Ken Lewis, CEO of Bank of America, at his home in Charlotte, North Carolina, and suggested a meeting. Perhaps unknowingly, perhaps unwittingly, and eerily similar to the BofA rescue of Countrywide months before, BofA and Merrill were being led to the altar in a marriage of convenience for someone. Some thought BofA was becoming the fifth branch of the U.S. government, JPMorganChase already being installed as the fourth.

But Lehman's position was not improving. They had teams of negotiators all over the building, in discussions with bankers and lawyers. Even Mark Walsh and his minions had arrived to help Barclays evaluate one of the most terrifying commercial real estate portfolios in the country. The Barclays guys were grilling Bart and Alex, trying to place a value on the corporation. One of their prime observations was ”The Lehman valuations on these a.s.sets are insane-what the h.e.l.l was Fuld doing? Him and this Gregory character.”

By Sat.u.r.day lunchtime, Barclays, unsurprisingly, had decided that whatever else they wanted, they did not want the Lehman commercial property empire. They were probably encouraged in this view by the findings of about three hundred other lawyers, accountants, and bankers who had also gazed in horror at the giant portfolio of concrete that d.i.c.k Fuld had so confidently praised on that Lehman conference call three days before. And everything was made more drastically difficult because Fuld, even when the writing was on the wall, had refrained from calling in the bankruptcy lawyers. Thus there had been no preliminary examination. The fact was, no one knew the answers to anything.

Right now all Fuld could do was drive the Lewis family nearly mad by calling the Bank of America boss every five minutes throughout that Sat.u.r.day. If it wasn't the longest day in Lehman's history, it was surely the longest day in the lifetimes of Ken and Donna Lewis.

By Sat.u.r.day night CNBC was talking openly about the demise of Lehman. They spoke as if the game was over, and anyone listening could have been in no doubt that Bank of America was out and the Barclays position was unpromising.

On Sunday morning, the streets around the Lehman headquarters were packed with reporters and television crews. A police line was established on the sidewalk as hundreds of Lehman employees began filing in, some carrying boxes, others with duffel bags. I took a walk along to my old office building just as the sorrowful procession of hardworking, talented staff members began to emerge one by one, holding their boxes.

I stood on the other side of the street and saw a few people I knew. Some of the women were in tears. Many of the guys were too upset even to look up. And the reporters crowded in on them shouting questions, demanding answers from people whose lives had just been shot to pieces, whose finances were decimated, lifestyles wrecked, in some cases, like mine, hearts broken.

I then saw Jeremiah Stafford cornered by the reporters. One of the toughest, fastest traders on Wall Street, whose expectations had been sky-high, he was just standing there with his box of possessions, wearing a Red Sox baseball cap. His life was in shreds, his dreams ruined, at least for the moment. I could see him fighting back the tears as he said how we had been expecting this for a while, but he and all of his closest colleagues would walk out with pride, knowing they had contributed. As he tore himself away from these intrusive strangers with their microphones and lenses and appalling sense of ent.i.tlement, he added, ”It was a very great place to have worked.” Right on, Jeremiah! He represents to me so much of what was right and so much of what was wrong with Lehman. There were so many talented traders like him, so many awesome hardworking investment bankers, salespeople, support people all over the globe. There were dozens and dozens of extremely profitable business engines and departments in the firm. It was like 24,992 people making dough and 8 losing it.

By now people were still arriving, driven by the fear that the Lehman bankruptcy might yet be so bad that the feds would move in and seize everything, bolting the doors, locking everyone out. But thus far Lehman had not filed, and while some may have thought there was still hope, most people knew it was over. Otherwise, why were there hundreds of media people camped outside the doors of 745 Seventh?

In fact, none of them knew about the single ray of hope that had glistened in one of the wood-paneled conference rooms of the Fed building shortly after nine-thirty that morning. Hank Paulson and the head of the New York Fed, Tim Geithner, had between them corralled a group of leading bank chiefs and convinced them to finance the SpinCo a.s.sets up to $40 billion. This was precisely what the guys from Barclays wanted to hear, and it effectively put a potential deal right back on track.

Bart McDade and Alex had, like everyone else, been at the Fed since 6:00 A.M. A.M. Mike Gelband was uptown at the law offices of Simpson, Thatcher, and Bartlett, Lehman's counsel, where they were tackling the ma.s.sive problem of due diligence. Just before ten o'clock, Bart e-mailed Mike informing him there was a deal: Barclays was making an acceptable offer for the firm. Mike Gelband was uptown at the law offices of Simpson, Thatcher, and Bartlett, Lehman's counsel, where they were tackling the ma.s.sive problem of due diligence. Just before ten o'clock, Bart e-mailed Mike informing him there was a deal: Barclays was making an acceptable offer for the firm.

Mike, who perhaps more than anyone had strived to save the bank that had outright rejected him, was almost overcome with relief. But twenty minutes later, his hopes were shattered. A new e-mail came in from Bart, announcing there had been a problem. In truth, there were two major holdups. The first was the British regulators, the FSA, who would not clear the deal because they had no wish to involve the British financial system with American difficulties. Hank Paulson himself had stepped in and talked with the regulators in London, but to no avail. Some have said that the FSA was willing to share the risk with the U.S. Treasury, but Paulson yet again said no.

The more pressing issue was Barclays shareholder approval. There was no way Hank was going to place a United States Treasury guarantee behind a deal that might face some kind of mutiny from British stockholders. And this deal needed to be done that day. Lehman did not have enough money to open for business on Monday, not without borrowing, and Jamie Dimon was simply not up to extending any more credit to Lehman. And so the great bankers of the United States stared down the twin barrels of two insurmountable problems, regulators and shareholders, while Barclays backed away.

No one could say they didn't give it everything, but the enmity between Paulson and Fuld s.h.i.+mmered below the surface. In the end, Fuld saw the Treasury boss as a Pete Peterson character, a smooth, highly educated Ivy League sports star, a dyed-in-the-wool investment banker who had risen effortlessly. Hank found d.i.c.k Fuld a somewhat graceless, arrogant character, devoid of humility even in this, Lehman's darkest hour.

And boy was it ever dark. Huge arc lights split the night out on Seventh Avenue, generators roared, and reporters shouted as the evening wore on. Media from all over the world were there, performing their dance of impending death: CBS, NBC, the BBC, Sky News, ITV. What's the mood like inside the building? How do you feel? How worried are you? What are the chances of a new job? What's the mood like inside the building? How do you feel? How worried are you? What are the chances of a new job? On this Sunday night their material was endless, because people were arriving all through the evening into the small hours, afraid of the lockout, afraid of losing years of mementos and personal possessions. On this Sunday night their material was endless, because people were arriving all through the evening into the small hours, afraid of the lockout, afraid of losing years of mementos and personal possessions.

The old distressed-bond trading department was united as it had not been for more than a year, since Mike and Larry left. Everyone was on the phone to everyone else, in a ma.s.s commiseration for the old firm. Everyone, in their own way, was upset: Joe, As.h.i.+sh, Pete, Grossy Sch.e.l.l. But the two I recall being most hurt of all were a couple of the staunchest operators in the company: the hard-nosed ace salesman Terence Tucker, too distressed to talk, and Jane Castle, a hundred pounds of h.e.l.l, too upset to come to the phone.

I had a long conversation with Pete Hammack, and as ever, he had a.s.sembled the facts and arrived at the firm conclusion that, no matter what, Hank Paulson had to save Lehman Brothers. There was no choice, he felt, because the calamity would be too great for the financial system if he let it go.

”The issue is the credit default swaps,” said Pete. ”There's $72 trillion of them out there held by seventeen banks, and Lehman must be sitting on $7 trillion of them. Likewise, since Lehman is a prime broker, what happens to all the other prime brokerages if Hank lets Lehman go? Right there you're talking Armageddon.” Pete had thought it through. ”If a hundred hedge funds have prime brokerage accounts with Lehman Brothers,” he said, ”each with $500 million at stake, that's $50 billion of stocks that will possibly be liquidated. And that amount of selling will cause a tsunami. Worse yet, all of these hedge funds are leveraged five times, maybe ten. That's $500 billion of selling, bonds, stocks, RMBSs, CMBSs, CDOs, et cetera. That's a mega-tsunami on steroids. That's what we have created, and Hank has no option except to stop it from happening.” No modern market has ever seen that type of selling.

Larry McCarthy did not share Pete's opinion. ”We're dead,” he told me with rich and characteristic cynicism, ”because Hank and his guys have seen the books.” Like me, he thought all hope was gone, though our reasons were slightly at variance. Personally, I thought Hank Paulson was going to do something like Custer's last stand, riding bravely in defense of capitalism at the head of his troops, and let the market do its worst. Trouble with that was everyone might get killed. Worse yet, the son of a b.i.t.c.h was going to do it with my money.

All my life I've been a laissez-faire Ronald Reagan/Margaret Thatcher capitalist, swearing by the market, taking the risks, and the devil take the hindmost. But this one time I was looking for a government rescue, and I wasn't going to get it.

Around eight on that Sunday night the Lehman negotiators returned to the office from the Fed building and went straight to the thirty-first floor. Bart McDade walked into d.i.c.k Fuld's crowded office and told him there would be no rescue, that it was over, that Lehman Brothers had been mandated to file for bankruptcy.

The Lehman CEO was dumbfounded. Lehman might easily go down for $660 billion, the largest bankruptcy in the history of the world.

Despite a growing feeling that the feds did not care one way or another whether Lehman lived or died, they decided to give it one more try-to phone directly the Brooklyn-born Tim Geithner, head of the Fed in New York. One more plea. One more appeal.

Fuld's legal counsel, Tom Russo, made the call in front of perhaps fifteen silent onlookers, the entire Lehman executive committee. It was 8:20 P.M. P.M. They tried reaching Geithner but could only get through to his number two at the New York Fed. But with the most momentous failure in the history of U.S. finance about to happen, no one could track down Geithner. They buzzed, paged, and rerouted. But Tim had gone to ground. It might have been just happenstance, but there was a melancholy feeling that it might equally well have been deliberate. In those empty minutes, the fighting heart of Lehman Brothers began to fall apart. They tried reaching Geithner but could only get through to his number two at the New York Fed. But with the most momentous failure in the history of U.S. finance about to happen, no one could track down Geithner. They buzzed, paged, and rerouted. But Tim had gone to ground. It might have been just happenstance, but there was a melancholy feeling that it might equally well have been deliberate. In those empty minutes, the fighting heart of Lehman Brothers began to fall apart.

But Mike Gelband and Bart were still in the game, and they decided there was one final card to play. It was a little embarra.s.sing, but still a slender chance. One of d.i.c.k's executive committee members was George Walker IV, a top-flight Ivy League investment banker with a Wharton MBA. He was also a cousin of the president of the United States, George W. Bush. They shared a great-grandfather. Walker, thirty-nine, was the firm's head of investment management, and understood with everyone the gravity of the situation, the decimation of his personal capital, the loss of his career. Now Mike Gelband stood before him and begged him to call the president, to ask his cousin to intervene.

Walker was scared. His s.h.i.+rt was absolutely soaked with sweat at the thought of calling the White House. ”I'm not sure I can do this,” he said. But Gelband knew they were drowning men. If George would not make the call, it really was over. Mike took him aside and told him flatly that if this phone call failed, it would ”unleash the forces of evil into the global markets.” It was the same message that had been delivered shortly before to Geithner's number two. George went white, almost overwhelmed by the responsibility now being foisted upon him.

”I'm not ordering you,” said Mike. ”I can't do that. I'm on my knees, George. Please, please make the call. It's our last shot.”

Eric Felder, the fixed-income chief, too implored him, saying quietly, ”We are looking at an unmitigated disaster on a global scale, George. They don't understand what they are doing. Like Mike, I'm begging you.”

Walker, distraught, pacing the room, looked over to d.i.c.k Fuld, who was on the line to the SEC. And then he went into the library and telephoned the president of the United States of America. Mike heard him request a connection to the private quarters of the president. It was obvious the operator was trying to put this family member through, but the delay seemed interminable, and finally the operator came back on the line and said, ”I'm sorry, Mr. Walker. The president is not able to take your call at this time.”

George Walker had failed, but he'd done his best. And now they all gathered around d.i.c.k Fuld's desk for the last time. Earlier in the day, the famous bankruptcy lawyer Harvey Miller and his team from Weil Gotshal had arrived and were now preparing for a bankruptcy filing that would be six times larger than any other Chapter 11 case in U.S. history.

Bankers were suggesting the $660 billion number was not far off the mark. They were talking $40 billion commercial real estate and mortgages, $65 billion in residential real estate and mortgages, and $16 billion in high-yield leveraged-buyout debt-grand total $121 billion. In addition, there was another $300 billion worth of commercial paper, overnight repos, and Treasury debt. Lehman owed $100 billion more in stocks, corporate bonds, munic.i.p.al bonds, and commodities, and another $100 billion in CDSs, CDOs, CLOs, options (puts/calls), and hedges on the ABX and the HY-9.

In the small hours of the morning, around two o'clock, Lehman Brothers filed for Chapter 11 bankruptcy. The 158-year-old investment bank was gone. It was Monday, September 15, in the year 2008. It was indeed the largest bankruptcy in history.

Hank Paulson had just made the decision that would obliterate the world's economy.

Epilogue.

Written in Sorrow, Not Anger.

Hours after Lehman's attorneys filed for Chapter 11 bankruptcy, Hank Paulson stood in the West Wing of the White House, and there, with the Stars and Stripes draped behind him, announced to the world that he had elected to allow Lehman Brothers to fail.

He uttered words of a.s.surance to Americans everywhere that U.S. banks were safe and their deposits were insured by the FDIC. ”I have played,” he said, ”the hand I was dealt.” And he surely had, because in the hours that preceded that press conference he had made certain that the collapsing Merrill Lynch had been forced into the arms of Bank of America in one of the truly great marriages of convenience.

Immediately after the press conference ended, he was told the markets were tumbling. The Dow Jones Industrial Average went into a savage downward spiral, dropping 500 points on the day. Hank Paulson, the great Republican banker, had gone with his instincts, and now he wrestled with the momentous decision he had made. He was a man with a complete aversion to anything that smacked of nationalization, and he had made the call of a red-in-tooth-and-claw American capitalist. The fourth-largest investment bank on Wall Street had gone down. And the U.S. government had raised not one finger to save it. All around the world, the markets shuddered as Wall Street's tectonic plates began to rumble apart. Everyone was on edge, braced for a new shock, and there was not long to wait.

On Tuesday morning, September 16, right on the NYSE opening bell, shares in the world's biggest insurance corporation, AIG, slid 60 percent as a direct result of the Lehman bankruptcy. AIG had been an enormous player in the credit default swaps market and had taken billions of dollars' worth of bets against the failure of Lehman, simply because it seemed to them an absolute impossibility that it could ever collapse. They had promised all these people billions of dollars in payouts because it was unthinkable that Lehman could go down, but now it had. AIG did not have the cash to make the payouts they now owed. In addition, they had invested tens of billions insuring profits in the lethal CDO markets, which had collapsed with ma.s.s defaults by the mortgage holders. AIG was effectively insolvent.

On that Tuesday morning, the ratings agencies, suddenly quivering with self-righteousness, downgraded them, which required AIG to post collateral with its trading counterparties. Right there, AIG had a liquidity crisis. With the stock plummeting to a low of $1.25, 95 percent off its fifty-two-week high, the insurers were on the brink of bankruptcy.

Hank Paulson, who had just let the fourth-largest bank on Wall Street slip away, could not possibly allow the biggest insurance company in the world to go down the tubes with it. Against all of his capitalist instincts, he stepped in, and the Federal Reserve immediately announced the creation of a secured credit facility of up to $85 billion. In return, Ben Bernanke demanded and received an 80 percent stake in the corporation for the government. Bailout number four had just broken out, six months after Bear Stearns and nine days after Fannie and Freddie; the total of government guarantees was now at $314 billion. Strangely, Goldman Sachs CEO Lloyd C. Blankfein was the only major head of any Wall Street investment bank present in the AIG bailout discussions that day. Goldman was a large holder of AIG stock as well as an enormous counterparty to over $10 billion in AIG credit default swaps. A lot of Lehman employees still want to know why the Lehman rescue plan proposed over the weekend was so public, with more than eight investment and commercial banks looking under the Lehman kimono, while the expensive bailout of AIG just a few days later was so private.

But the biggest question on everyone's mind remains. How much did the Lehman failure cost the U.S. government in terms of ma.s.sive additional bailout funds for AIG? With Lehman in bankruptcy and all the forced selling it created in the markets, some say Lehman's failure cost tens of billions. No one knows. If Lehman was saved, do you really think it would have cost an initial $80 billion and subsequently $180 billion in taxpayer funds for the AIG bailout?

With Lehman's bankruptcy filing less than forty-eight hours old, the full impact of the disaster hit the world's financial markets. The biggest banks on earth were, collectively, terrified to lend to each other, because none of them had any confidence they would ever get their money back. If it could happen to Lehman, it could happen to anyone. The heart of the global banking system, the credit markets, was frozen solid. There was no possibility of anyone securing a loan for anything, especially the investment banks. The short-term paper market ceased to exist. The safest, most solid banks in the world were unable to borrow money.

This was not just a difficult time, with banks stopping to catch their breath. This was a meltdown, and commerce in the United States was rapidly stalling. Hank Paulson was facing the beginning of the global credit crunch, the very same one Mike Gelband had warned him about on the telephone from d.i.c.k Fuld's office seventeen months before.

Just then Hank was gazing with horror at one of those mysterious Wall Street insider's charts known in the trade as the TED spread, a measure that perceived credit risk in the general economy. It's the difference between the interest rates for three-month U.S. Treasury contracts-risk-free T-bills paying roughly 1.5 percent-and the interest banks charge each other for short-term loans, LIBOR, around 2 percent. Historically the TED spread hovers between 10 and 50 basis points (that's 0.1 percent and 0.5 percent)-a tiny difference, and a very dull little chart, occasionally worth checking. The day after AIG crashed, however, the TED spread went into orbit, shooting up 300 basis points. It broke the record set after the Black Monday collapse of 1987. Visions of the Great Depression of the 1930s danced before Hank Paulson's eyes. According to this chart, the banks had slammed an enormous interest rate on every dollar they loaned. Reason: they did not want to lend, and this explosion on the TED spread signified they were not joking. They'd made it impossible for anyone to borrow money.

Even the dying breed of America's AAA-rated companies-and by now there were only six of them left-could not borrow money at that price. It's probably worth noting that in 1980 there were more than sixty nonfinancial companies that held the highest possible rating. Now there were only Automatic Data Processing (ADP), ExxonMobil, General Electric, Johnson & Johnson, Pfizer, and Microsoft, and even these uncontested champions of the credit food chain were left without nourishment.